Levin Company Is Considering Two New Machines That Should Produce $\quad \quad \quad \quad \quad \quad\text { Annual After-tax Cash Savings }$

question 112

Essay

Levin Company is considering two new machines that should produce considerable cost savings in its assembly operations.The cost of each machine is $14,000 and neither is expected to have a salvage value at the end of a 4-year useful life.Levin's required rate of return is 12% and the company prefers that a project return its initial outlay within the first half of the project's life.The annual after-tax cash savings for each machine are provided in the following table: $\quad \quad \quad \quad \quad \quad\text { Annual After-tax Cash Savings }$
$\begin{array}{|l|r|r|}\hline \text { Year: } & \quad\quad\text { Machine A } & \quad \quad\text { Machine B } \\\hline1& \$ 5,000 & \$ 8,000 \\\hline 2&5,000 & 6,000 \\\hline3&5,000 & 4,000 \\\hline4& \underline { 5,000} & \underline { 2,000} \\\hline 5& \underline { \$ 20,000} & \underline { \$ 20,000} \\\hline\end{array}$ Required:
1)Compute the payback period for each machine using the incremental approach and comment on the results.
2)Compute the unadjusted rate of return based on average investment for each machine.The machines will be depreciated on a straight-line basis.
3)Compute the net present value for each machine.
4)Which machine would you recommend? Explain your reasoning.
5)Use the present value table to compute the approximate internal rate of return for Machine.

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Definitions:

Present Value

The value today of a sum of money to be received in the future, after accounting for a certain return rate.

Compound Interest

Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It's the result of reinvesting interest rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.

Earnings Rate

The return on an investment for a specific period, typically expressed as a percentage of the investment's initial cost.

Internal Rate Of Return

A financial metric used to evaluate the profitability of potential investments, calculated as the discount rate that makes the net present value of all cash flows from a project equal to zero.