Waterways (Chapter 27)
For this assignment, you will apply what you have learned from the unit lesson and required unit resources.
Waterways puts much emphasis on cash flow when it plans for capital investments. The company chose its discount rate of 8% based on the rate of return that it must pay its owners and creditors. Using that rate, Waterways then uses different methods to determine the best decisions for making capital outlays.
This year, Waterways is considering buying five new backhoes to replace the backhoes it now has. 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 Backhoe. New Backhoe
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
- In the following methods, evaluate whether to purchase the new equipment or to 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.)
- Are there any intangible benefits or negatives that would influence this decision?
- What decision would you make, and why?