Runder Company Is Evaluating a Proposal to Purchase a New

question 45

Essay

Runder Company is evaluating a proposal to purchase a new machine that would cost $100,000 and have a salvage value of $10,000 in four years.It would provide annual operating cash savings of $10,000,as follows: $\begin{array}{lrr}&\text { Old Machine}&\text { New Machine }\\\text { Salaries } & \$ 40,000 & \$ 36,000 \\\text { Supplies } & 7,000 & 5,000 \\\text { Maintenance } & 9,000 & 5,000 \\\text { Total } & \$ 56,000 & \$ 46,000\end{array}$ If the new machine is purchased,the old machine will be sold for its current salvage value of $20,000.If the new machine is not purchased,the old machine will be disposed of in four years at a predicted salvage value of $2,000.The old machine's present book value is $40,000.If kept,in one year the old machine will require repairs predicted to cost $35,000.
Dale Davis's cost of capital is 14%.
Required: Should the new machine be purchased? Why or why not?

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Definitions:

Net Present Value

A calculation used to assess the profitability of an investment by determining the difference between the present value of cash inflows and outflows.

Incremental Cash Flows

Additional cash flows from taking on a new project, crucial for analysis in capital budgeting decisions to determine a project's potential profitability.

Capital Budgeting

Analysis techniques concerned with justifying money spent on long-term assets and projects.

Profitability

A measure of the efficiency of a company or investment in generating profit or return compared to its revenue or investment size.