The following scenario is from the Unit 3 Individual Project:
Klottier & Walson, Inc. plans to upgrade 1 of the pieces of equipment in its factory. The current equipment has been fully depreciated and does not offer any tax benefits to the company. Although it is still functioning, the equipment's current model is more cost-efficient and breaks much less than previous models. Furthermore, the company feels that the new model will provide a more reliable product for some new customers. By utilizing the model, the company can save money in production and outsourcing costs.
The new model costs $150,000 (delivered and installed), with an expected life of 5 years. The company expects that the new equipment will cost approximately $1,000 more in utilities than what it now pays. The company will also spend $500 per month for an extended warranty. The new model is more complex and requires hiring someone to program it. The base salary of this new employee will be $36,000, plus applicable payroll taxes and benefits, which add up to be an additional 20% per year. However, the company projects that the new equipment will be much faster, and it would be able to fulfill $75,000 worth of extra orders per year. The management believes that the cost of capital would be 10% and that after the equipment is fully depreciated, the equipment will have 0 value and will be discarded.
You have been hired to determine the following:
• What is the payback period for the project?
• What is the profitability index for the project?
• What are the advantages and disadvantages of each method when making decisions on a capital investment project?
• From Unit 3, you have the NPV and IRR. From the Unit 4 calculations, you have payback and profitability index. Using these ratios, what is your suggestion to the company regarding the purchase of this equipment? Explain your rationale.