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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

UNEQUAL LIVES Cotner Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: (a) Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and (b) Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98,300 per year. Assume that both projects can be repeated. Knitting machine prices are not expected to rise because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Cotner’s WACC is 14%. Using the replacement chain and EAA approaches, which model should be selected? Why?

Summary Introduction

To Determine: The suitable models that should be selected using replacement chain and EAA approaches.

Introduction: The replacement chain is a technique of capital budgeting decision model that is utilized to look at least two mutually exclusive capital recommendations with uneven lives.

Explanation

Determine the equivalent annual annuity for Machine 190-3

Using a excel spreadsheet and excel function =PMT, the equivalent annual annuity for Machine 190-3 is $5,161.02.

Excel Spreadsheet:

Excel Workings:

Therefore the equivalent annual annuity for Machine 190-3 is $5,161.02.

Determine the expected net present value for Machine 190-3

ExpectedNPVMachine1903=[NPV+(NPVMachine1903(1+Rate)n)]=[$11,981.99+($11,981.99(1+14%)3)]=[$11,981

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