Equipment Replacement and Strategic Considerations The management of DevineInstrument Company is considering the purchase of a new drilling machine, model RoboDril 1010K.According to the specifications and testing results, RoboDril will substantially increase productivityover AccuDril X10, the machine Devine is currently using.The AccuDril was acquired 8 years ago for $120,000 and is being depreciated using the straightline method over a 10-year expected life and an estimated salvage value of $20,000. The engineering department expects the AccuDril to keep going for another 3 years after a major overhaul atthe end of its expected useful life. The estimated cost for the overhaul is $100,000. The overhauledmachine will be depreciated using straight-line depreciation with no salvage value. The overhaulwill improve the machine’s operating efficiency approximately 20% for each of years 3, 4, and 5. Noother operating conditions will be affected by the overhaul.RoboDril 1010K is selling for $250,000. Installing, testing, rearranging, and training will costanother $30,000. The manufacturer is willing to take the AccuDril as a trade-in for $40,000. TheRoboDril will be depreciated using the straight-line method with no salvage value. New technologymost likely will make RoboDril obsolete to the firm in 5 years.Variable operating cost for either machine is the same: $10 per machine hour (cash-based). Otherpertinent data follow:[LO 12-1, 12-4, 12-8]AccuDril X10 RoboDril 1010KUnits of output (per year) 10,000 10,000Machine hours 8,000 4,000Selling price per unit $100 $100Variable manufacturing cost—cash-based (not includingmachine hours) $40 $40Other annual expenses (tooling and supervising) $95,000 $55,000Disposal value—today $25,000Disposal value—in 5 years $0 $50,000Devine Instrument Company’s weighted-average cost of capital (WACC) is 12%, and it is in the40% tax bracket. Use the PV factors (Appendix C, Table 1) for calculating the NPV of each decisionalternative.Required1. Determine for each of years 0 though 5 (inclusive) the after-tax cash flows for items that differ betweenthe two alternatives. Express all cash flow amounts in thousands (000s); round individual amounts to 1decimal place. 2. Compute the payback period (in years) for purchasing RoboDril 1010K rather than having AccuDrilX10 overhauled in 2 years. Assume for this calculation only that all cash flows (other than those relatedto the net acquisition cost of the replacement asset)—including tax effects—occur evenly throughoutthe year. Round your answer to 1 decimal place (e.g., 2.812 years = 2.8 years). 3. Using results generated in requirement 1, what is the present value of each decision alternative, keep vs.replace? State all cash flows in thousands (000s); round each of your two answers to 1 decimal place.(Use the built-in NPV function in Excel to calculate present values.) 4. What other factors, including strategic issues, should the firm consider before making a final decision?
Equipment Replacement and Strategic Considerations The management of Devine
Instrument Company is considering the purchase of a new drilling machine, model RoboDril 1010K.
According to the specifications and testing results, RoboDril will substantially increase productivity
over AccuDril X10, the machine Devine is currently using.
The AccuDril was acquired 8 years ago for $120,000 and is being depreciated using the straightline method over a 10-year expected life and an estimated salvage value of $20,000. The engineering department expects the AccuDril to keep going for another 3 years after a major overhaul at
the end of its expected useful life. The estimated cost for the overhaul is $100,000. The overhauled
machine will be depreciated using straight-line
will improve the machine’s operating efficiency approximately 20% for each of years 3, 4, and 5. No
other operating conditions will be affected by the overhaul.
RoboDril 1010K is selling for $250,000. Installing, testing, rearranging, and training will cost
another $30,000. The manufacturer is willing to take the AccuDril as a trade-in for $40,000. The
RoboDril will be depreciated using the straight-line method with no salvage value. New technology
most likely will make RoboDril obsolete to the firm in 5 years.
Variable operating cost for either machine is the same: $10 per machine hour (cash-based). Other
pertinent data follow:
[LO 12-1, 12-4, 12-8]
AccuDril X10 RoboDril 1010K
Units of output (per year) 10,000 10,000
Machine hours 8,000 4,000
Selling price per unit $100 $100
Variable
machine hours) $40 $40
Other annual expenses (tooling and supervising) $95,000 $55,000
Disposal value—today $25,000
Disposal value—in 5 years $0 $50,000
Devine Instrument Company’s weighted-average cost of capital (WACC) is 12%, and it is in the
40% tax bracket. Use the PV factors (Appendix C, Table 1) for calculating the
alternative.
Required
1. Determine for each of years 0 though 5 (inclusive) the after-tax cash flows for items that differ between
the two alternatives. Express all cash flow amounts in thousands (000s); round individual amounts to 1
decimal place.
2. Compute the payback period (in years) for purchasing RoboDril 1010K rather than having AccuDril
X10 overhauled in 2 years. Assume for this calculation only that all cash flows (other than those related
to the net acquisition cost of the replacement asset)—including tax effects—occur evenly throughout
the year. Round your answer to 1 decimal place (e.g., 2.812 years = 2.8 years).
3. Using results generated in requirement 1, what is the
replace? State all cash flows in thousands (000s); round each of your two answers to 1 decimal place.
(Use the built-in NPV function in Excel to calculate present values.)
4. What other factors, including strategic issues, should the firm consider before making a final decision?
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