The Cosmo K Manufacturing Group currently has sales of $1,400,000 per year. It is considering the addition of a new office machine, which will not result in any new sales but will save the company $105,500 before taxes per year over its 5-year useful life. The machine will cost $300,000 plus another $12,000 for installation. The new asset will be depreciated using a modified accelerated cost recovery system (MACRS) 5-year class life. It will be sold for $25,000 at the end of 5 years. Additional inventory of $11,000 will be required for parts and maintenance of the new machine. The company evaluates all projects at this risk level using an 11.99% required rate of return. The tax rate is expected to be 35% for the next decade.
Tasks:
Answer the following questions:
- What is the total investment in the new machine at time = 0 (T = 0)?
- What are the net cash flows in each of the 5 years of operation?
- What are the terminal cash flows from the sale of the asset at the end of 5 years?
- What is the NPV of the investment?
- What is the IRR of the investment?
- What is the payback period for the investment?
- What is the profitability index for the investment?
- According to the decision rules for the NPV and those for the IRR, is the project acceptable?
- Is there a conflict between the two decision methods? If so, what would you use to make a recommendation?
- What are the pros and cons of the NPV and the IRR? Explain your answers.
