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Capital Budgeting: Investing in New Equipment and Work Space

1. Prince Company's required rate of return is 10%. The company is considering the purchase of three machines, as indicated below. Consider each machine independently. For this question, ignore income taxes.

(a) Machine A will cost $25,00 and have a life of 15 years. Its salvage value will be $1,000, and cost savings are projected at $3,500 per year. Compute the machine's net present value.

(b) How much will Prince Company be willing to pay for Machine B if the machine promises annual cash inflows of $5,000 per year for 8 years?

(c) Machine C has a projected life of 10 years. What is the machine's internal rate of return if it costs $30,000 and will save $6,000 annually in cash operating costs? Interpolate to the nearest tenth of a percent. Would you recommend purchase? Explain.

2. Bradley Company's required rate of return is 14%. The company has an opportunity to be the exclusive distributor of a very popular consumer item. No new equipment would be needed, but the company would have to use one-fourth of the space in a warehouse it owns. The warehouse cost $200,000 new. The warehouse is currently half-empty and there are no other plans to use the empty space.

In addition, the company would have to invest $100,000 in working capital to carry inventories and accounts receivable for the new product line. The company would have the distributorship for only 5 years. The distributorship would generate a $17,000 net annual cash inflow. Ignore income taxes for this problem.

What is the net present value of the project at a discount rate of 14%? Should the project be accepted?

Solution Summary

This solution determines the cost of invest in new equipment and warehouse space.