Petroleum Drilling, Inc., is considering installation of a new automated drilling equipment.
The new equipment can be installed for $11,750,000 today and will have a life of 6 years until technological obsolescence due to rapid advances in drilling control technology. At the end of its 6 year life, its components will have a salvage value of $2,750,000, and it will cost $324,500 to have the equipment removed. The equipment will be depreciated under MACRS. The equipment will produce $7,975,000 additional sales capacity per year due to productivity gains. Additional technical labor cost will be $2,305,000 per year and operating and maintenance costs will be $885,000 per year. The company is in a western state with no corporate income taxes and is in the 35% federal tax bracket. Estimate both the annual net income and annual cash flow. The company’s MARR for this project is 20.0%. Based on net present value estimate, do you recommend installing the automated refining line? What is the equivalent uniform annual worth and IRR of the project?