Automated teller machines (ATM\'s) have become common in the banking industry. S

Question

Automated teller machines (ATM's) have become common in the banking industry. San Angelo Federal Bank is planning to replace some old teller machines and has decided to use the York Machine. Nola Chavez, the controller, has prepared the analysis shown at the top of the next page. She has recommended the purchase of the machine based on the positive net present value shown in the analysis.
The York Machine has an estimated useful life of five years and an expected residual value of $35,000. Its purchase price is $385,000. Two existing ATM's each having a carrying value of $25,000, can be sold to a neighboring bank for a total of $50,000. Annual operating cash inflows are expected to increase in the following manner:
Year 1 $79,900
Year 2 $76,600
Year 3 $79,900
Year 4 $83,200
Year 5 $86,500

San Angelo Federal Bank
Capital Investment Analysis
Net Present Value Method

Year Net Cash Inflows Present Value Factor Present Value
1 $85,000 0.909 $77,265
2 $80,000 0.826 $66,080
3 $85,000 0.751 $63,835
4 $90,000 0.683 $61,470
5 $95,000 0.621 $58,995
5(Residual value) $35,000 0.621 $21,735
Total present value: $349,380
Initial investement $385,000
Less proceeds from the sale of $50,000
existing teller machines
Net capital investment ($335,000)
Net present value $14,380

The San Angelo Federal Bank uses straight line depreciation. The minimum rate of return is 12%.
1. Analyze Chavez's work. What changes need to be made in her capital investement analysis?
2. What would be your recommendation to bank management about the purchase of the York Machine?

Explanation / Answer

1. The changes that need to be made to capital Investment Analysis : a. The Present Value of residual value need not be found out. b. Instead , the present value of salvage value has to be added to the cash inflows of year 5. c Hence the cash Flows in year 5 would become 95,000 +50,000= 145,000 Now , the analysis would look something like this : 1 85,000.00 0.12 0.89 75,892.86 2 85,000.00 0.12 0.80 67,761.48 3 85,000.00 0.12 0.71 60,501.32 4 85,000.00 0.12 0.64 54,019.04 5 145,000.00 0.12 0.57 82,276.89 Total Cash Flows 340,451.59 Less Initial Investment 385,000.00 NPV (44,548.41) The above analysis shows a negative NPV. Based on the above analysis, the machine should not be purchased. 1 85,000.00 0.12 0.89 75,892.86 2 85,000.00 0.12 0.80 67,761.48 3 85,000.00 0.12 0.71 60,501.32 4 85,000.00 0.12 0.64 54,019.04 5 145,000.00 0.12 0.57 82,276.89 Total Cash Flows 340,451.59 Less Initial Investment 385,000.00 NPV (44,548.41)

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