Problem:
Compare two alternatives for equipment purchases using capital budgeting techniques.
To be honest, I don't even know where to start with this problem and would appreciate any help that you feel is allowed. At least something that could get me started and allow me to check my work when finished. Thank you for your help.
Zimman Manufacturing Company is considering two alternative equipment purchases. Equipment X costs $1 million, has an expected life of 5 years, and generates after-tax cash flows of $350,000 per year. At the end of 5 years, the salvage value of the original Equipment is zero, but the company will be able to purchase another Equipment X at a cost of $1.2 million. The second Equipment X will generate after-tax cash flows of $375,000 a year for another 5 years at which time its salvage value will again be zero.
Alternatively, the company can buy Equipment B at a cost of $1.5 million today. Equipment B will produce after-tax cash flows of $400,000 a year for 10 years, and after 10 years it will have an after-tax salvage value of $100,000. Assume that the cost of capital is 12 percent.