A company has the opportunity to purchase a new high-tech metal cutter which will save the company $14,000 each year in labor costs. This metal cutter cost $70,000. At the end of the useful life of seven years, the salvage value is expected to be $16,000. Depreciation is via the straight-line method.
If the company goes ahead with the new metal cutter, it can sell its old cutter for $5,000, even though the machine has a net book value of $8,000 presently.
The new machine will require a working capital injection of $4,500 for the acquisition of additional scrap metal. The working capital would be recovered at the end of the seven-year period. The company’s required rate of return is 10 percent. The marginal rate of tax is 30 percent.
Required:
- Calculate the net present value of the cutter project.
- Discuss two factors to be considered before the company acquires the new metal cutter.
- Critically evaluate the use of the payback period for companies that release new product models frequently.
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