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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

UNEQUAL LIVES Overton Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: (a) Machine 171 3, which has a cost of $171,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $85,000 per year, and (b) Machine 356-6, which has a cost of $356,000, a 6-year life, and after -tax cash flows of $102,400 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 (microprocessor) used in the machines. Assume that Overton's WACC is 13%. 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 173-3

Using a excel spreadsheet and excel function =PMT, the equivalent annual annuity for Machine 173-3is $12,577.74.

Excel Spreadsheet:

Excel Workings:

Therefore the equivalent annual annuity for Machine 173-3 is $12,577.74.

Determine the expected net present value for Machine 173-3

ExpectedNPVMachine1733=[NPV+(NPVMachine1733(1+Rate)n)]=[$29,697.97+($29,697.97(1+13%)3)]=[$29,697

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