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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