Hughes Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of $2,600,000. If refurbished, Hughes expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of $3,800,000. A new machine would last 10 years and have no residual value. Hughes expects the following net cash inflows from the two options: Year Refurbish Current Purchase New Machine Machine $ 1,760,000 $ 2,970,000 2 440,000 490,000 360,000 410,000 4 280,000 330,000 200,000 250,000 6 200,000 250,000 7 200,000 250,000 200,000 250,000

Hughes Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of $2,600,000. If refurbished, Hughes expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of $3,800,000. A new machine would last 10 years and have no residual value. Hughes expects the following net cash inflows from the two options: Year Refurbish Current Purchase New Machine Machine $ 1,760,000 $ 2,970,000 2 440,000 490,000 360,000 410,000 4 280,000 330,000 200,000 250,000 6 200,000 250,000 7 200,000 250,000 200,000 250,000

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

Hughes Manufacturing, Inc. has a manufacturing machine that needs attention.
The company is considering two options. Option 1 is to refurbish the current
machine at a cost of $2,600,000. If refurbished, Hughes expects the machine to
last another eight years and then have no residual value. Option 2 is to replace
the machine at a cost of $3,800,000. A new machine would last 10 years and
have no residual value. Hughes expects the following net cash inflows from the
two options:
Year
Refurbish Current Purchase New
Machine
Machine
1
$ 1,760,000
$ 2,970,000
2
440,000
490,000
360,000
410,000
4
280,000
330,000
200,000
250,000
200,000
250,000
200,000
250,000
200,000
250,000
6799O

9.
250,000
10
250,000
Total
$ 3,640,000
$ 5,700,000
Hughes uses straight-line depreciation and requires an annual return of 10%.
Requirements
1. Compute the payback, the ARR, the NPV, and the profitability index of
these two options.
1. Refurbish $257,880 NPV; Purchase 2.8 years payback
2. Which option should Hughes choose? Why?

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Calculation of ARR:

NPV option 1

NPV option 2

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