Question
The management of Booth Manufacturing Company is evaluating a proposal to purchase a new drill press as a replacement for a piece of similar equipment,
The management of Booth Manufacturing Company is evaluating a proposal to purchase a new drill press as a replacement for a piece of similar equipment, which would then be sold. The cost of the new drill press is $87,500. If the equipment is purchased, Booth will incur $2,500 of costs for setup. The new equipment will require a major overhaul after 5 years, costing $5,000. The present equipment has a book value of $25,000 and a remaining useful life of 10 years. The market value of the present equipment now is also $25,000. Management has provided you with the following comparisons: Present Equipment New Equipment
Annual production in units 200,000 250,000 .
Sales revenue from each unit produced $0.15 $0.15
Annual expenses:
Direct labour $15,000 $12,500
Depreciation expense $ 2,500 $ 8,750
Other cash operating costs $ 24,000 $10,000
The company uses a 14% discount rate in evaluating capital projects and expects investments to have a payback of 5 years or less. Both the existing and new equipment have a negligible salvage value at the end of 10 years. Income taxes are to be ignored. In each case, indicate whether the proposed project should be accepted and why.
REQUIRED: a) Calculate the net present value of the project using the incremental-cost approach and completing the table provided below. (8 marks)
b) Calculate the payback period for the new equipment. (3 marks)
c) Calculate the Simple rate of return for the new equipment. (3 marks)
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