question archive A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods

A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods

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A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods. The details for each option are provided below:

Option 1 

  • $65,000 for equipment with useful life of 7 years and no salvage value. 
  • Maintenance costs are expected to be $2,700 per year and increase by 3% in Year 6 and remain at that rate. 
  • Materials in Year 1 are estimated to be $15,000 but remain constant at $10,000 per year for the remaining years. 
  • Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after. 

Revenues are estimated to be: 

Year 1Year 2Year 3Year 4Year 5Year 6Year 7-  75,000  100,000  125,000  150,000  150,000  150,000

Option 2 

 

  • $85,000 for equipment with useful life of 7 years and a $13,000 salvage value 
  • Maintenance costs are expected to be $3,500 per year and increase by 3% in Year 6 and remain at that rate. 
  • Materials in Year 1 are estimated to be $20,000 but remain constant at $15,000 per year for the remaining years. 
  • Labor is estimated to start at $60,000 in Year 1, increasing by 3% each year after. 

Revenues are estimated to be:

 

Year 1Year 2Year 3Year 4Year 5Year 6Year 7-  80,000  95,000  130,000  140,000  150,000  160,000

The company's required rate of return and cost of capital is 8%.

Management has turned to its finance and accounting department to perform analyses and make a recommendation on which option to choose. They have requested that the four main capital budgeting calculations be done: NPV, IRR, Payback Period, and ARR for each option.

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