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# Capacity Planning / Present Value Method: Two machines

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1. Evaluate Machine A and Machine B.
Assume:
A. The life of each machine is 3 years
B. The company thinks it knows how to make 14% on investments no more risky than this one.

2. Determine, via Present Value Method, which machine should be recommended. Explain your decision. What assumptions are you making about the machines? What assumptions are you making in your methodology?
3. Please explain in details how/what/why you did what you did in this exercise and list the solutions which you have came up with. In other words, provide a written summary of this exercise so that I understand exactly how you did it.

See attachment for more details.

#### Solution Preview

See the attached file for complete solution. The text here may not be copied exactly as some of the symbols / tables may not print. Thanks

Capacity Planning

1. Evaluate Machine A and Machine B.
Assume:
A. The life of each machine is 3 years
B. The company thinks it knows how to make 14% on investments no more risky than this one.
2. Determine, via Present Value Method, which machine should be recommended. Explain your decision. What assumptions are you making about the machines? What assumptions are you making in your methodology?
3. Please explain in details how/what/why you did what you did in this exercise and list the solutions which you have came up with. In other words, provide a written summary of this exercise so that I understand exactly how you did it.

Machine ...

#### Solution Summary

This post illustrates in a step by step manner how to take a capital investment decisions (capacity planning) by using NPV method. The problem is set up in Excel for easy understanding. Could be used as a good practice for the exam preparation.

\$2.19

## The Net Present Value Method

Please solve the attached questions E12 to 4B.

E12-1B Allen Corporation is considering purchasing a new delivery truck. The truck has many advantages over the company's current truck (not the least of which is that it runs). The new truck would cost \$48,000. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of \$8,000. At the end of 8 years the company will sell the truck for an estimated \$20,000. Traditionally the company has used a rule of thumb that a proposal should not be accepted unless it has a payback period that is less than 70% of the asset's estimated useful life. Achin Ceban, a new manager, has suggested that the company should not rely solely on the payback approach, but should also employ the net present value method when evaluating new projects. The company's cost of capital is 9%.

Instructions
(a) Compute the cash payback period and net present value of the proposed investment.
(b) Does the project meet the company's cash payback criteria? Does it meet the net present value criteria for acceptance? Discuss your results.

E12-2B Kogama Manufacturing Company is considering three new projects, each requiring an equipment investment of \$25,000. Each project will last for 3 years and produce the following cash inflows.

Year AA BB CC
1 \$ 7,000 \$ 9,600 \$13,000
2 9,000 9,600 9,000
3 12,000 9,600 11,000
Total \$28,000 \$28,800 \$33,000

The equipment's salvage value is zero. Kogama uses straight-line depreciation. Kogama will not accept any project with a payback period over 2.5 years. Kogama's minimum required rate of return is 12%.

Instructions
(a) Compute each project's payback period, indicating the most desirable project and the least desirable project using this method. (Round to two decimals.)
(b) Compute the net present value of each project. Does your evaluation change? (Round to nearest dollar.)

E12-3B SWC Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn't equipped to do. Estimates regarding each machine are provided below.

Machine A Machine B
Original cost \$98,000 \$170,000
Estimated life 8 years 8 years
Salvage value -0- -0-
Estimated annual cash inflows \$25,000 \$40,000
Estimated annual cash outflows \$5,000 \$12,000

Instructions
Calculate the net present value and profitability index of each machine. Assume a 10% discount rate. Which machine should be purchased?

E12-4B Valdez Inc. manufactures snowsuits. Valdez is considering purchasing a new sewing machine at a cost of \$2.4 million. Its existing machine was purchased five years ago at a price of \$1.8 million; six months ago, Valdez spent \$55,000 to keep it operational. The existing sewing machine can be sold today for \$260,000. The new sewing machine would require a one-time, \$85,000 training cost. Operating costs would decrease by the following amounts for years 1 to 7:

Year 1 \$390,000
2 400,000
3 411,000
4 426,000
5 434,000
6 435,000
7 436,000

The new sewing machine would be depreciated according to the declining-balance method at a rate of 20%. The salvage value is expected to be \$380,000. This new equipment would require maintenance costs of \$95,000 at the end of the fifth year. The cost of capital is 10%.

Instructions
Use the net present value method to determine whether Valdez should purchase the new machine to replace the existing machine, and state the reason for your conclusion. (CGA adapted)

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