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Cost Savings in Assembly Operations Analysis

Brown Company is considering two new machines that should produce considerable cost savings in its assembly operations. The cost of each machine is $15,000 and neither is expected to have a salvage value at the end of a 4-year useful life. Brown's required rate of return is 12% and the company prefers that a project return its initial outlay within the first half of the project's life. The annual after-tax cash savings for each machine are provided in the following table:

Annual After Tax Cash Savings
Year Machine A Machine B
1 $5,000 $8,000
2 5,000 6,000
3 5,000 4,000
4 5,000 2,000
Total $20,000 $20,000

a. Compute the payback period for each machine using the incremental approach.
b. Compute the unadjusted rate of return based on average investment for each machine. The machines will be depreciated on a straight-line basis.
c. Compute the net present value for each machine.
d. Which machine would you recommend? Explain your reasoning.
e. Compute the internal rate of return for Machine A.

Solution Preview

Undajusted rate of return computed on the basis of average investment is 16.67%, but its coming out to be equal for both and also its not an appropriate measure as it
does not take care of time value of money. Thus we should consider NPV and IRR.
Here NPV ...

Solution Summary

This solution shows step-by-step calculations to determine the net present value, internal rate of return, payback period, unadjusted rate of return and provides a recommendation of machine selection with justification.