Bramble Fashions needs to replace a beltloop attacher that currently costs the c
ID: 2569638 • Letter: B
Question
Bramble Fashions needs to replace a beltloop attacher that currently costs the company $38,000 in annual cash operating costs. This machine is of no use to another company, but it could be sold as scrap for $2,090. Managers have identified a potential replacement machine, Euromat’s Model HD-435. The HD-435 is priced at $73,124 and would cost Bramble Fashions $28,000 in annual cash operating costs. The machine has a useful life of 13 years, and it is not expected to have any salvage value at the end of that time. Click here to view the factor table.
(a) Calculate the net present value of purchasing the HD-435, assuming Bramble Fashions uses a 8% discount rate.
(b) Calculate the internal rate of return on the HD-435.
(c) Calculate the payback period of the HD-435.
(d) Calculate the accounting rate of return on the HD-435.
(e) Should Bramble Fashions purchase the HD-435?
Explanation / Answer
a) Net present value = PV of total cash inflow - Initial investment Cost of new machine = $73124 Receipts from sale of old machine = $2090 Net cost of new machine = $73124-$2090 = $71034 Annual savings in cash operating costs = $38000-$28000 = $10000 PV of total cash inflow = $10000*PVIFA @8% 13 years = 10000 * 7.904 = $79040 NPV = $79040-$73124 = $8006 b) IRR can be calculated by using trial and error method NPV using 8% discounting rate = $8006 NPV using 11% discounting rate = $67499($10000*6.7499)-$73124 = -3535 IRR = Lower rate + ((NPV at lower rate-required NPV)/(NPV at lower rate-NPV at higher rate))*(higher rate-lower rate) = 8 + ((8006-0)/(8006--3535))*(11-8) = 8+(8006/11541)*3 = 8+0.6937*3 = 8+2.01 = 10% (approx) c) Pay back period = Net initial investment / annual operating cash flow = 71034/10000 = 7.1 years d) Accounting rate of return = Average return during period / Average investment Average investment = (Book value at the beginning+Book value at the end)/2 = (71034+0)/2 = $35517 Average return during the period = Increamental revenue (including depreciation) = $10000+(73124/13) = $15625 ARR = $15625/$35517 = 44% e) yes. Because the NPV is positive and good ARR also