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Capital Budgeting Decisions

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Hammerlink Company has been offered a special-purpose metal-cutting machine for $110,000. The machine is expected to have a useful life of eight years, with a terminal disposal value of $30,000. Savings in cash operating costs are expected to be $25,000 per year. However, additional working capital is needed to keep the machine running efficiently and without stoppages. Working capital includes such items as filters, lubricants, bearings, abrasives, flexible exhaust pipes, and belts. These items must continually be replaced, so an investment of $8,000 must be maintained in them at all times, but this investment is fully recoverable (will be "cashed in") at the end of the useful life. Hammerlink's required rate of return is 14%. Ignore income taxes in your analysis.

1. Compute net present value.

2. Compute internal rate of return.

3. Compute accrual accounting rate of return based on net initial investment. Assume straight-line depreciation.

4. You have the authority 10 make the purchase decision. Why might you be reluctant to base your decision on the DCF methods?

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Solution Summary

Computes net present value, internal rate of return, accrual accounting rate of return.

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