Evaluate the Capital Investment

 Project: Evaluate the Capital Investment 


Scenario


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
 
   
 
    Instructions


1. Evaluate, discuss, and compare whether to purchase the new  equipment or overhaul the old equipment. (Hint: For the old machine, the  initial investment is the cost of the overhaul. For the new machine,  subtract the salvage value of the old machine to determine the initial  cost of the investment.)
 

  • Calculate the net present value of the old backhoes and the new backhoes.
  • Discuss the net present value of each, including what the  calculations reveal about whether the company should purchase the new  backhoes or continue using the old backhoes.
  • Calculate the payback period for keeping the old backhoes and  purchasing the new backhoes. (Hint: For the old machines, evaluate the  payback of an overhaul.)
  • Discuss the payback method and what the payback periods of the  old backhoes and new backhoes reveal about whether the company should  purchase new backhoes or continue using the old backhoes. Calculate the  profitability index for keeping the old backhoes and purchasing new  backhoes.
  • 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.

2. Identify and discuss any intangible benefits that might influence this decision.

3. Answer the following: Should the company purchase the new backhoes  or continue using the old backhoes? Explain your decision.

This course requires the use of Strayer Writing Standards. For  assistance and information, please refer to the Strayer Writing  Standards link in the left-hand menu of your course. Check with your  professor for any additional instructions.
The specific course learning outcome associated with this assignment is:
 

  • Analyze the financial condition of a company using vertical, horizontal, and ratio analysis to make informed decisions.

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