Shoals Corporation puts significant emphasis on cash flow when planning capital investments. The company chose its discount rate of 8 percent based on the rate of return it must pay its owners and creditors. Using that rate, Shoals Corporation then uses different methods to determine the most appropriate capital outlays. This year, Shoals Corporation is considering buying five new backhoes to replace the backhoes it now owns. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes. The following information is available to use in deciding whether to purchase the new backhoes: Old Backhoes New Backhoes Purchase cost when new $90,000 $200,000 Salvage value now $42,000 Investment in major overhaul needed in next year $55,000 Salvage value in 8 years $15,000 $90,000 Remaining life 8 years 8 years Net cash flow generated each year $30,425 $43,900 Discuss the profitability index of each, including what the calculations reveal about whether the company should purchase the new backhoes or continue using the old backhoes.
Shoals Corporation puts significant emphasis on cash flow when planning capital investments. The company chose its discount rate of 8 percent based on the
This year, Shoals Corporation is considering buying five new backhoes to replace the backhoes it now owns. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes.
The following information is available to use in deciding whether to purchase the new backhoes:
|
|
Old Backhoes |
|
New Backhoes |
|
Purchase cost when new |
$90,000 |
|
$200,000 |
|
Salvage value now |
$42,000 |
|
|
|
Investment in major overhaul needed in next year |
$55,000 |
|
|
|
Salvage value in 8 years |
$15,000 |
|
$90,000 |
|
Remaining life |
8 years |
|
8 years |
|
Net cash flow generated each year |
$30,425 |
|
$43,900 |
- Discuss the profitability index of each, including what the calculations reveal about whether the company should purchase the new backhoes or continue using the old backhoes.
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