ABC Company is considering the purchase of
a numerical-controlled machine for use in its production. The machine would
cost $675,000. An additional $487,500 would be required for installation cost
and for software. Management believes that the automated machine would provide
substantial annual reductions in cash costs, as shown below.

Labor cost $180,000 (Annual reduction in
cash costs)

Material costs $72,000(Annual reduction in
cash costs)

The new machine would require considerable
maintenance work to keep it in proper adjustment. The company’s engineers
estimate that maintenance costs would increase by $3,200 per month if the
machine were used. In additional, the machine would require a $67,500 overhaul
at the end of the fifth year.

The new machine would be usable for eight
years, after which it would be sold for an estimated scrap value of $157,500.
The new machine would replace an old machine that can be sold now for its scrap
value of $52,500. ABC Company requires a return of at least 16% on investment
of this type.

Compute the net annual cash
cost savings promised by the new machine excluded depreciation and the overhaul
at the end of year 5

Using the data from part 1 and
other data from the problem, using the tables of present values provided and ignoring
income tax issues, compute the new machine’s net present value. Use the
incremental-cost approach

Assume that management can
identify several intangible benefits associated with the new machine, included
greater flexibility in production, improved quality in output and reduced
throughout time. What dollar value per year would management have to attach to
these intangible benefits in order to make the new machine an acceptable

Now, instead of intangible
benefits, assume that management is told that the new machine can be sold at
the end of its useful life for a much higher salvage value of $720,000. Should
management approve the investment?


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