Capital Budgeting The Hunter Company makes cookies for its chain of snack food s
ID: 2746036 • Letter: C
Question
Capital Budgeting
The Hunter Company makes cookies for its chain of snack food stores. On January 1, 2013 the Company purchased a special cookie cutting machine and has used this machine for the three-year period ending December 31, 2015. On January 1, 2016 Hunter is considered the purchase of a newer, more efficient, machine. If purchased, the new machine would be put into operation immediately (January 1, 2016). Either machine could be used for the next four years (2016, 2017, 2018, 2019)
Hunter expects to sell 300,000 dozen cookies in each of the next 4 years at an average price of $1.25 per dozen.
Hunter gives you the following information:
Old
Machine
New
Machine
Original cost at date of acquisition
$140,000
$200,000
Useful life from the date of acquisition
7 years
4 years
Expected cash operating expenses:
Variable cost per dozen cookies
$.40 per dozen
$.30 per dozen
Total fixed costs per year
$25,000
$20,000
Estimated cash value of machines:
January 1, 2016
$60,000
December 31, 2019
$0
$50,000
Annual Depreciation expense (under the straight-line method)
$20,000
$50,000
Hunter uses straight line depreciation for tax reporting purposes. The Company is subject to a marginal tax rate of 30 percent and has an after tax WACC of 14 percent.
Required:
1. Prepare a schedule showing the following relevant cash flows if Hunter purchases this investment.
a. Initial outflow if purchase the new machine and sell the old machine (at January 1, 2016).
b. Annual operating cash flows for each of the fours year period 2016, 2017, 2018, & 2019.
c. Residual (salvage) cash flow at December 31, 2019 upon the sale of the new machine.
2. Calculate the NPV if Hunter purchases the new machine.
3. Calculate the IRR if Hunter purchases the new machine.
4. Should Hunter purchase the new machine?
Old
Machine
New
Machine
Original cost at date of acquisition
$140,000
$200,000
Useful life from the date of acquisition
7 years
4 years
Expected cash operating expenses:
Variable cost per dozen cookies
$.40 per dozen
$.30 per dozen
Total fixed costs per year
$25,000
$20,000
Estimated cash value of machines:
January 1, 2016
$60,000
December 31, 2019
$0
$50,000
Annual Depreciation expense (under the straight-line method)
$20,000
$50,000