Problem:
Custom Driveways provides custom paving of sidewalks and driveways for residential and commercial customers. One of the most labor-intensive aspects of the paving operation is the preparation an mixing of materials. Joe Click, corporate engineer, has learned of a new computerize technology to mix (and monitor mixing of) materials. According to information received by Mr. Click, the cost of the required equipment would be $280,000, and the equipment would have an expected life of seven years. If purchased, the new equipment would replace manually operated equipment. Data relating to the old and new mixing equipment follow:
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OLD TECHNOLOGY
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Original cost
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$25,000
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Present book value
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$15,000
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Annual cash operating costs
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$75,000
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Current market value
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$6,000
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Market value in 7 years
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$0
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Remaining useful life
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7 years
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NEW TECHNOLOGY
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Cost
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$280,000
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Annual cash operating costs
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$15,000
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Market value in 7 years
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$0
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Useful life
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7 years
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a. Assume that the cost of capital in this company is 12 percent, which is the rate to be used in a discounted cash flow analysis. Compute the net present value and profitability index of investing in the new machine. Ignore taxes. Should the machine be purchased? Why or why not?
b. Compute the payback period for the investment in the new machine. Ignore taxes.
c. Rounding to the nearest whole percentage, compute the internal rate of return for the machine investment.