1. Your company wants to bring outdoor ice-skating to Palm Springs, California and must choose between two refrigeration machines that do the same job but have different life spans. The two machines have the following investment and operating costs in each year: Year 0. 1 3 Machine A $10,000 $1,100 $1,100 & Replace Machine B $12,000 $1,100 $1,200 $1,300 & Replace These costs are expressed in real (inflation adjusted) terms. Assume a 5 percent real discount rate. Note that machine A would operate in periods 1 and 2 only, while mạchine B would operate in periods 1 through 3. A. Explain whether the concept of Equivalent Annual Cost (EAC) would be useful for evaluating these two investments. In your answer please define EAC. B. As the company's financial manager, if you had to buy one or the other machine, which one would you buy. Why? C. Now suppose you have an existing machine that you can keep operating for one more year only, but it will cost $2,500 in repairs and $1,800 in operating costs. Is it worth replacing with machine A or B? 2. Suppose that it is January 1990 and the New Economy Transport Company (NETCO) is evaluating a proposed expenditure of $400,000 for a new engine and general overhaul of one of its boats used to push barges up and down the Ohio River. The estimated annual operating costs after the overhaul are $1,234,000. The boat is fully depreciated, so that the depreciation tax shield from the decision to overhaul would be based on the incremental investment of $400,000. The controller feels that it is unwise to proceed with the overhaul before considering the purchase of a new boat. A new boat would cost $2,000,000 payable now and with
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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