VacuTech is a high-technology company that manufactures sophisticated testing instrument for evaluating microcircuits. These instruments sell for $3,500 each and cost $2,450 each to manufacture. An essential component of the companys manufacturing process is a sealed vacuum chamber where the interior approaches a pure vacuum. The technology of the vacuum pumps that the firm uses to prepare its chamber for sealing has been changing rapidly. On January 2, 20X1, VacuTech bought the latest in electronic high-speed vacuum pumps, a machine that allowed the company to evacuate a chamber for sealing in only six hours. The company paid $400,000 for the pump. Recently, the manufacturer of the pump approached VacuTech with a new pump that would reduce the evacuation time to two hours. VacuTechs management is considering the acquisition of this new pump and has asked Melanie Harris, the controller, to evaluate the financial impact of replacing the existing pump with the new model. Harris has gathered the following information prior to preparing her analysis.

The new pump would be installed on December 31,20X3 and placed in service on January 1, 20X4. The cost of the pump is $608,000, and the costs for installing, testing, and debugging the new pump will be $12,000. VacuTech uses straight-line depreciation with a half year convention. The pump is expected to have a salvage value of $80,000 when sold at the end of four years.

The old pump will be fully depreciated at the time the new pump is placed in service. If the new pump is purchased, arrangements will be made to sell the old pump for $40,000, the estimated salvage value on December 31, 20X3.

At the current rate of production, the new pumps greater efficiency will result in annual cash savings of $125,000.

VacuTech is able to sell all of the testing instruments it can produce. Because of the increased speed of the new pump, output is expected to be 30 units greater in 20X4 than in 20X3. In 20X5 and 20X6, production will be 50 units greater than in 20X3. The production in 20X7 will exceed 20X3 production by 70 units. For all additional units produced, the manufacturing costs would be reduced by $150 per unit.

VacuTech is subject to a 40 percent tax rate. For evaluating capital investment proposals, VacuTechs management uses a 16 percent after-tax discount rate.

REQUIRED:

1. Determine whether or not VacuTech should purchase the new pump by calculating the net present value of the investment.

2. Describe two factors that VacuTech should consider before making the pump replacement decision. These should not be related to regular capital budgeting techniques that are available (i.e., net present value, payback, IRR, and accrual accounting rate of return).