Leonard owns a coffee shop. One of his coffee machines is in bad shape. He plans to overhaul the machine or replace it with another coffee machine. Coffee machines typically last for 5 years and provides annual revenues of P 15,000, and Leonard's discount rate for decision making purposes is 10%. If he gets another coffee machine, the old one will be sold right away, which he can sell for P 10,000. Here are his options. A. He can ask a machine specialist to overhaul his old coffee machine, which will cost him P 35,000. The annual repair cost for the first year will be P 1,000, which doubles every year. Scrap value is negligible. B. He can purchase a second-hand coffee machine, which will cost him P 45,000. Annual repairs will amount to P 5,000. Scrap value is negligible. C. He can purchase a brand-new coffee machine, which will cost him P 65,000. Annual repair amounting to P 4,000 will start on the third year. Scrap value of this coffee machine is negligible. Required: A. Compute for the net present value, project profitability index, and internal rate of return for each alternative. Which one should Leonard choose? Explain. B. How much is the total undiscounted cash flows for the overhaul alternative? C. Under the third alternative, how much should Leonard sell the new coffee machine for after its useful life for this alternative to be deemed acceptable? Use NPV approach to solve this problem.

Personal Finance

13th Edition

ISBN:9781337669214

Author:GARMAN

Publisher:GARMAN

Chapter8: Vehicle And Other Major Purchases

Section: Chapter Questions

Problem 1FPC

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Transcribed Image Text:Leonard owns a coffee shop. One of his coffee machines is in bad shape. He plans to overhaul the machine or replace it with another coffee machine. Coffee machines typically last for 5 years and provides annual revenues of P 15,000, and Leonard's discount rate for decision making purposes is 10%. If he gets another coffee machine, the old one will be sold right away, which he can sell for P 10,000. Here are his options. A. He can ask a machine specialist to overhaul his old coffee machine, which will cost him P 35,000. The annual repair cost for the first year will be P 1,000, which doubles every year. Scrap value is negligible. B. He can purchase a second-hand coffee machine, which will cost him P 45,000. Annual repairs will amount to P 5,000. Scrap value is negligible. C. He can purchase a brand-new coffee machine, which will cost him P 65,000. Annual repair amounting to P 4,000 will start on the third year. Scrap value of this coffee machine is negligible. Required: A. Compute for the net present value, project profitability index, and internal rate of return for each alternative. Which one should Leonard choose? Explain. B. How much is the total undiscounted cash flows for the overhaul alternative? C. Under the third alternative, how much should Leonard sell the new coffee machine for after its useful life for this alternative to be deemed acceptable? Use NPV approach to solve this problem.

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