Waterways puts much emphasis on cash flow when it plans for capital investments. The company chose its discount rate of 8% based on the rate of return it must pay its owners and creditors. Using that rate, Waterways then uses different methods to determine the best decisions for making capital outlays.
This year Waterways is considering buying five new backhoes to replace the backhoes it now has. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes.
The following information is available to use in deciding whether to purchase the new backhoes.
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Old Backhoes
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New Backhoes
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Purchase cost when new |
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$90,000 |
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$202,784 |
Salvage value now |
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$41,600 |
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Investment in major overhaul needed in next year |
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$55,510 |
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|
Salvage value in 8 years |
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$15,000 |
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$90,000 |
Remaining life |
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8 years |
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8 years |
Net cash flow generated each year |
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$30,500 |
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$43,800 |
Evaluate in the ways whether to purchase the new equipment or overhaul the old equipment. (Hint:
For the old machine, the initial investment is the cost of the overhaul. For the new machine, subtract the salvage value of the old machine to determine the initial cost of the investment.).
I have attached two images. Image 1 shows the additional details. I need help on solving the question in image 2.
Extracted text: Given: New Backhoes Old Backhoes 90000 41600 55510 15000 8 30500 Particulars Purchase cost when new Salvage value now Investment in major overhaul needed in next year Salvage value in 8 years Remaining life Net cash flow generated each year Discount rate 202784 90000 8 43800 0.08 0.08 Step 2 A D E F G 1 Particulars 2 Purchase cost when new 3 Salvage value now 4 Investment in major overhaul needed in next year New Backhoes Old Backhoes $90,000 $41,600 $55,510 $15,000 Old Backhoes New Backhoes S202,784 Cash flows Year -$51,398 $30,500 $30,500 $30,500 $30,500 $30,500 $30,500 $30,500 $45,500 -$161,184 $43,800 $43,800 $43,800 $43,800 $43,800 $43,800 $43,800 5 Salvage vahue in 8 years 6 Remaining life 7 Net cash flow generated each year 8 Discount rate $90,000 1 2 $43,800 S30,500 8% 8% 4 9 10 Present value of overhaul 11 Present value of net cash flows $51,398.15 6 $251,702.79 $175,272.49 7 12 Present value of salvage value 13 Net present value 14 Payback period 15 Profitability index(PI) $48,624.20 $8,104.03 8. $133,800 $139,142.99 $131,978.37 1.69 3.68 1.9 3.6 16 17 Net present value $139,143 Buy New Backhoes, as NPV highest $131,978 18 Water way should 19 Payback period 1.69 3.68 Buy New Backhoes, as Lowest 20 Water way should Payback periodhighest 21 Profitability index 1.9 3.6 22 Water way should Buy old Backhoes, as PI highest
Extracted text: Calculate the internal rate of return factor for the new and old blackhoes. (Round answers to 5 decimal places, e.g. 5.27647.) New Backhoes Old Backhoes IRR Factor (4) Comparing the internal rate of return for each choice to the required 8% discount rate. Waterways should equipment.