The management of Devine Instrument Company is considering the purchase of a new drilling machine, model RoboDril 1010K. According to the specifications and testing results, RoboDril will substantially increase productivity over AccuDril X10, the machine Devine is currently using.

The AccuDril was acquired 8 years ago for $80,000 and is being depreciated using the straight-line method over a 10-year expected life and an estimated salvage value of $20,000. The engineering department expects the AccuDril to keep going for another 3 years after a major overhaul at the end of its expected useful life. The estimated cost for the overhaul is $100,000. The overhauled machine will be depreciated using straight-line depreciation with no salvage value. The overhaul will improve the machines operating efficiency approximately 10% for each of years 3, 4, and 5. No other operating conditions will be affected by the overhaul.

RoboDril 1010K is selling for $240,000. Installing, testing, rearranging, and training will cost another $20,000. The manufacturer is willing to take the AccuDril as a trade-in for $30,000. The RoboDril will be depreciated using the straight-line method with no salvage value. New technology most likely will make RoboDril obsolete to the firm in 5 years.

Variable operating cost for either machine is the same: $11 per machine hour (cash-based). Other pertinent data follow:

	AccuDril X10				RoboDril 1010K
Units of output (per year)		10,000				10,000
Machine hours		8,000				4,000
Selling price per unit	$	100			$	100
Variable manufacturing costcash-based	$	20			$	20
(not including machine hours)
Other annual expenses (tooling and supervising)	$	70,000			$	40,000
Disposal valuetoday	$	25,000
Disposal valuein 5 years	$	0			$	50,000

Devine Instrument Companys weighted-average cost of capital (WACC) is 8%, and it is in the 40% tax bracket. Use the PV factors (Appendix C, Table 1) for calculating the NPV of each decision alternative.

Required:

1. Determine for each of years 0 though 5 (inclusive) the after-tax cash flows for items that differ between the two alternatives.

2. Compute the payback period (in years) for purchasing RoboDril 1010K rather than having AccuDril X10 overhauled in 2 years. Assume for this calculation only that all cash flows (other than those related to the net acquisition cost of the replacement asset)including tax effectsoccur evenly throughout the year.

3. Using results generated in requirement 1, what is the present value of each decision alternative, keep vs. replace?