The equipment has a delivered cost of $57,000. An additional $3,000 is required to install the new equipment. The new control device falls into the 7-year class for depreciation and will be depreciated using MACRS as per the Tax Reform Act of 1986 and a further modification in 2005. At the end of 8 years, the estimated Salvage Value of the new equipment is $20,000.The existing control device has been in use for approximately 10 years, and it has been fully depreciated (that is, its book value is zero for the old device). However, its current market value for the old device is estimated to be $5,000. The applicable tax rate is 34%. The new control device requires lower maintenance costs and frees personnel who would otherwise monitor the system. In addition, it reduces product wastage. In total, it is estimated that during its eight-year life, the yearly savings will amount to $20,000 if the new control device is used. Yearly sales revenue is unchanged. The illustrative firm’s cost of capital is 16%.
1. Develop a capital budgeting schedule that evaluates the relative merits of replacing the old machine with the new one. Use the NPV methodology and show the basis for all of your inputs. Based on NPV, make an investment decision on this project proposal, and state why you made this decision.
2. The required payback for the new control device is six years.
a. Calculate the payback period for the new equipment.
b. Make an investment decision based on your payback calculation.
c. Calculate the discount payback period.
3. What are the IRR and MIRR on this project? Make an investment decision.
4. What would be the effect on NPV and IRR if the new control device falls into the 5-year class for depreciation? Assume all the original info remains unchanged. Make an investment decision.
5. What would be the effect on the NPV if straight-line depreciation is used rather than MARCS?