Question
Woodmill of Muskoka specializes in outdoor furniture that is practical, comfortable and contemporary. Their products are designed from natural cedar and recycled plastic. Woodmill of
Woodmill of Muskoka specializes in outdoor furniture that is practical, comfortable and contemporary. Their products are designed from natural cedar and recycled plastic. Woodmill of Muskokas product lines include chairs, tables, bunkies and even lighthouses.
In 2021, Woodmill of Muskoka is planning to upgrade its existing equipment. The required rate of return for such investments is 9%. Currently, the company is reviewing the following two options:
Option A: To purchase a new coating equipment for the cedar furniture product line. The equipment costs $563,000 and is expected to last 10 years. It is estimated to result in the following savings per year: $56,800 direct materials costs, $65,450 maintenance and repairs costs and $74,630 direct labour costs. The new machine will result in increased utilities costs of $47,650 per year. At the end of its useful life, the machine will have no salvage value.
Option B: To purchase a new assembly line for the recycled plastic furniture product line. The assembly line costs $638,000 and is expected to lasts 12 years. The annual savings in operating costs are estimated to be $63,800 direct material costs, $65,200 direct labour and $48,400 maintenance and repairs costs. In addition, there is an estimated increase in the utilities costs of $38,250 per year. The end of its useful life, the filling machine will have no salvage value.
Instructions
(a) Determine the expected net annual cash flow for the above two options? (5 marks)
(b) Compute the internal rate of return for both options. Clearly state the PV factor(s) used. (3 marks)
(c) Which equipment should Woodmill of Muskoka purchase? Why? (1 marks)
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