Potential investments to accelerate profit: ABC company has the option to purchase additional equipment that will cost about $42,000, and this new equipment will produce the following savings in factory overhead costs over the next five years:
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Year 1, $15,000
Year 2, $13,000
Year 3, $10,000
Year 4, $10,000
Year 5, $6,000
ABC Company uses the net-present-value method to analyze investments and desires a minimum rate of return of 12% on the equipment.
a. What is the net present value of the proposed investment (ignore income taxes and depreciation)?
b. Assuming a 5-year straight-line depreciation, how will this impact the factory’s fixed costs for each of the 5 years (and the implied product costs)? What about cash flow?
c. Considering the cash flow impact of the equipment as well as the time-value of money, would you recommend that ABC Company purchases the equipment? Why or why not?