# Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost $9,000,000 and last 10 years. The company’s cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchased—even if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of$1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of $300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the company’s decision? BuyFindarrow_forward ### Cornerstones of Cost Management (C... 4th Edition Don R. Hansen + 1 other Publisher: Cengage Learning ISBN: 9781305970663 #### Solutions Chapter Section BuyFindarrow_forward ### Cornerstones of Cost Management (C... 4th Edition Don R. Hansen + 1 other Publisher: Cengage Learning ISBN: 9781305970663 Chapter 19, Problem 15E Textbook Problem 45 views ## Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows:The system will cost$9,000,000 and last 10 years. The company’s cost of capital is 12 percent.Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchased—even if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of $1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of$300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the company’s decision?

1.

To determine

Calculate the payback period for the given system and state whether system would be acquired or not.

### Explanation of Solution

Payback period: Payback period is the expected time period which is required to recover the cost of investment. It is one of the capital investment method used by the management to evaluate the proposal of long-term investment (fixed assets) of the business. But payback method has high risk than other method, because it does not follow the time value of money concept in valuing the cash inflows.

Calculate the payback period for the given system and state whether system would be acquired or not as follows:

When the estimated annual net cash is equal (even cash flow), the cash payback period is calculated as below:

PaybackPeriod=Amount to be investedEstimated annual net cash inflow =$9,000,000$1,500,000 (1)=6.00years

Working note (1):

Calculate the annual cash flow of the investment

2.

To determine

Calculate the net present value (NPV) and internal rate of return (IRR) for the given project, and indicate whether the given project is better for the investment or not.

3.

To determine

Recalculate the payback period, net present value and internal rate of return of the project based on the given changes.

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