Moore Manufacturing is currently operating at its full capacity of 15,000 units per year; however, even at full capacity, it is not able to keep up with demand for its products. Demand is estimated at 20,000 units per year, which is expected to continue for the next four years.
In order to meet demand, Moore Manufacturing is considering purchasing new equipment costing $550,000. The equipment has an expected useful life of 4 years and has an expected salvage value of $50,000. Installation of the machine is estimated to cost $45,000 before it can be used for production.
The company has made arrangements to lease a nearby warehouse for $12,000 per year over the next four years. The company will need to invest an additional $24,000 in renovations to the warehouse to make it suitable for the firm’s purposes. The lease agreement requires the company to restore the warehouse to its original condition at the end of the lease. The cost of this restoration is estimated to be $25,000.
Current operating data is as follows:
|Operating Income before tax||$55|
The purchase of the new equipment will have no effect on variable costs per unit. The current fixed costs are expected to remain the same. Current per-unit fixed costs include depreciation expenses of $5 for manufacturing and $4 for marketing and administration.
If the equipment is purchased, fixed manufacturing costs (not including depreciation on the new equipment) of $125,000 will be incurred annually. The company would need to hire an additional marketing manager to serve new customers, at a cost of approximately $100,000. The firm is expected to be in the 40% tax bracket for the next four years. Moore Manufacturing requires a minimum after-tax return of 12 percent on investments and uses straight-line depreciation.
What is the initial investment outlay?
What effect will the purchase of the new equipment have on operating profit after-tax for each of the four years?
What effect will the purchase of the equipment have on after-tax cash inflows for each of the four years?
Calculate the payback period for this investment.
Calculate the book (accounting) rate of return for the investment, based on the average book value of the investment.
Calculate the net present value NPV of the investment.
Calculate the discounted payback period for the investment.
Calculate the internal rate of return (IRR) for the investment.
Prepare a memo that summarizes your calculations and makes a recommendation regarding this investment.