A junior executive is fed up with his boss's operating policies. Before leaving the office of his angered superior, the young man suggests that a well-trained monkey could handle the trivia assigned to him. Pausing a moment to consider the import of this closing statement, the boss is seized by the thought that this must have been in the back of her own mind ever since she hired the junior executive. She decides to consider replacing the executive with a bright young baboon. She figures that she could argue strongly to the board that such "capital deepening" is necessary for the cost-conscious firm. Two days later, a feasibility study is completed, and the following data are presented to the president:
? It would cost $12,000 to purchase and train a reasonably alert baboon with a life expectancy of 20 years.
? Annual expenses of feeding and housing the baboon would be $4,000.
? The junior executive's annual salary is $7,000 (a potential saving if the baboon is hired).
? The baboon will be depreciated on a straight-line basis over 20 years to a zero balance.
? The firm's marginal tax rate is 40 percent.
? The firm's current cost of capital is estimated to be 11 percent.
On the basis of the net present value criterion, should the monkey be hired (and the junior executive fired)?
Please see the attached file.
PVIFA= Present Value Interest Factor for an Annuity
It can be read from tables or calculated using the following equation
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
Incremental cash flow:
Saving on annual salary of the junior ...
The solution calculates the NPV of hiring a monkey in place of a junior executive.