Reference no: EM132438569

Question - B Inc. wants to replace its R & D equipment with new hi tech equipment. The existing equipment was purchased 5 years ago, on January 1, 2009, at a cost $150,000. At that time, the equipment had an expected life of 10 years with an expected salvage value of zero. This equipment has since then been depreciated on a straight line basis. As at January 1, 2014, its current market value is $75,000.

The new hi tech equipment can be purchased for $200,000 including installation as at January 1, 2014. Over this new equipment's expected 10 year useful life, savings in raw material usage and overhead costs will result in reductions in R & D costs of $21,000 annually for years 1 to 6; $38,800 for years 7, 8 and 9; a terminal year saving of $30,000 in year 10.

It is estimated that the new equipment can be sold for $50,000 at the end of its useful life on January 1, 2024. Since the new equipment's' cash flows are relatively certain, the project's cost of capital is set at 10%.

The firm normally requires a maximum payback period of 5 years for such projects.

Required -

1. Calculate the initial investment amount.

2. Calculate the project's cash payback period.

3. Calculate the project's net present value.

4. Make a recommendation as to whether the company should or should not replace the old R & D equipment with the new hi tech equipment. Provide evidence to justify your recommendation considering quantitative and qualitative factors.