Crofton Inc

question 153

Essay

Crofton Inc.is evaluating new machinery in its foundry.The machinery would replace existing equipment.The new machinery would cost $230,000, would last 5 years, and would have a salvage value of $28,000.The existing machinery currently has a net book value of $52,000 and could be sold for $38,000.If kept, the old machine would have a salvage value of $6,000 in 5 years' time.The new machinery is expected to lower direct labour costs by $18,000 per year.The current variable overhead rate is 120% of direct labour.Other annual cost savings are projected to be $30,000.Due to the reduction in the production cycle time, working capital requirements will decrease by $25,000 during the life of the new machine.Ignore income taxes.Required:
a.Compute the net present value of replacing the existing equipment at a 9 percent required rate of return.
b.Compute the internal rate of return.

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Definitions:

Variable Costing

An approach in accounting that takes into account only the variable aspects of production costs (such as direct materials, direct labor, and variable manufacturing overhead) in the computation of product prices.

Net Operating Income

Net Operating Income is a measure of a company's profitability from its regular business operations, excluding income and expenses from interest, taxes, and other non-operational activities.

Fixed Manufacturing Overhead

Regular, constant expenses related to the production process that are not affected by the level of goods produced, such as rent and salaries of management.

Ending Inventory

The total value of all inventory that a company still has on hand at the end of a reporting period.