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Soal Capital Budgeting Chapter 11

The Supreme Shoe Company is considering replacing an old machine with a new automated machine. The old machine cost $40,000 originally, can now be sold for $22,000, and costs $6,000 annually for maintenance and $4,000 for defects. The new machine would cost $75,000 with additional $6,000 for shipping and installation, but only $5,000 for maintenance and $2,000 for defects. An analysis determined the company's existing facilities could support the new machine without other changes. The company must take on $30,000 in debt at 10% interest for the new machine. Management will only accept the project if the investment can be recovered within 3 years.

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204 views

Soal Capital Budgeting Chapter 11

The Supreme Shoe Company is considering replacing an old machine with a new automated machine. The old machine cost $40,000 originally, can now be sold for $22,000, and costs $6,000 annually for maintenance and $4,000 for defects. The new machine would cost $75,000 with additional $6,000 for shipping and installation, but only $5,000 for maintenance and $2,000 for defects. An analysis determined the company's existing facilities could support the new machine without other changes. The company must take on $30,000 in debt at 10% interest for the new machine. Management will only accept the project if the investment can be recovered within 3 years.

Uploaded by

febrythiodor
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Project Capital Budgeting

The Supreme Shoe Company is considering the purchase of a new, fully automated
machine to replace a manually operated one. The machine being replaced, now five
years old, originally had an expected life of 10 years, is being depreciated using the
straight-line method from $40,000 down to $0 and can now be sold for $22,000. It
takes one person to operate the machine and he earns $29,000 per year in salary
and benefits.
The annual costs of maintenance and defects on the old machine are $6,000
and $4,000, respectively. The replacement machine being considered has a
purchase price of $75,000 and an expected salvage value of $15,000 at the end of
its five-year life. There will also be shipping and installation expenses of $6,000.
Because the new machine would work faster, investment in net working capital
would increase by a total of $3,000. The company expects that annual maintenance
costs on the new machine will be $5,000 while defects will cost $2,000.
Before considering this project, the company undertook an engineering
analysis of current facilities to determine if other changes would be necessitated by
the purchase of this machine. The study cost the company $5,000 and determined
that existing facilities could support this new machine with no other changes. In
order to purchase the new machine, the company would have to take on new debt
of $30,000 at 10% interest, resulting in increased interest expense of $3,000 per
year. The required rate of return for this project is 15% and the companys marginal
tax rate is 34%. Furthermore, management has determined that the maximum
allowable time to recover its investment is three years. Is this project acceptable?

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