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The management of Devine Instrument Company is considering the purchase of a new drilling machine, model RoboDril 1010K. According to the specifications and testing results, RoboDril will substantially increase productivity over AccuDril X10, the machine Devine is currently using.

The AccuDril was acquired 8 years ago for $120,000 and is being depreciatedusing the straight-line method over a 10-year expected life and an estimated salvage value of $20,000. The engineering department expects the AccuDril to keep going for another 3 years after a major overhaul at the end of its expected useful life. The estimated cost for the overhaul is $100,000. The overhauled machine will be depreciated using straight-line depreciation with no salvage value. The overhaul will improve the machine's operating efficiency approximately 20% for each of years 3, 4, and 5. No other operating conditions will be affected by the overhaul.

RoboDril 1010K is selling for $250,000. Installing, testing, rearranging, and training will cost another $30,000. The manufacturer is willing to take the AccuDril as a trade-in for $40,000. The RoboDril will be depreciated using the straight-line method with no salvage value. New technology most likely will make RoboDril obsolete to the firm in 5 years.

Variable operating cost for either machine is the same: $10 per machine hour (cash-based). Other pertinent data follow:

AccuDril

X10RoboDril

1010KUnits of output (per year)10,00010,000Machine hours8,0004,000Selling price per unit$100$100Variable manufacturing cost?cash-based$40$40(not including machine hours)Other annual expenses (tooling and supervising)$95,000$55,000Disposal value?today$25,000Disposal value?in 5 years$0$50,000

Devine Instrument Company's weighted-average cost of capital (WACC) is 12%, and it is in the 40% tax bracket. Use the PV factors (Appendix C, Table 1) for calculating the NPV of each decision alternative.

Required:

1. Determine for each of years 0 though 5 (inclusive) the after-tax cash flows for items that differ between the two alternatives.

2. Compute the payback period (in years) for purchasing RoboDril 1010K rather than having AccuDril X10 overhauled in 2 years. Assume for this calculation only that all cash flows (other than those related to the net acquisition cost of the replacement asset)?including tax effects?occur evenly throughout the year.

3. Using results generated in requirement 1, what is the present value of each decision alternative, keep vs. replace?

CoursHeroTranscribedText: After-tax Cash Flows PV of Net Cash Outflows 10 1 2 3 5 Overhaul AccuDril After-tax cash operating cost Overhaul cost (capitalized) Tax savings on depreciation (straight-line method) Other cash expenses, after tax After-tax cash flows Total PV Buy RoboDril 1010k Net equipment purchase After-tax cash operating cost Tax savings on depreciation Other cash expenses, after tax After-tax salvage value After-tax cash flows Total PV PV Difference in cash flows between alternatives Req l and 3 Req 2 Compute the payback period (in years) for purchasing RoboDril 1010K rather than having AccuDril X10 overhauled in 2 years. Assume for this calculation only that all cash flows (other than those related to the net acquisition cost of the replacement asset)including tax effectsoccur evenly throughout the year. [Round your answer to 1 decimal place.)

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