Widget Company is considering upgrading its manufacturing equipment. The Vice-President of Production has identified three possible actions Widget could take to accomplish the upgrade. One option would upgrade their current equipment and the other two options would replace the existing equipment with purchases of new equipment. The review committee has asked you to review each of the options to identify relevant cost data and to prepare a schedule comparing the three options. Your analysis schedule is to include comparative relevant costs and a net present value calculation. Option One: Using this option Widget would upgrade their current equipment to make it more efficient. The equipment, which is fully depreciated and has reached the end of its projected useful life, would be upgraded at a cost of $125,000. The upgrades would extend the useful life of the equipment by 5 years. The cost of the upgrade would be depreciated over the new 5 year useful life and result is tax savings (a cash inflow) of $750 per year. At the end of the 5 year useful life, you estimate the equipment can be sold for $65,000. Option Two: This option would require Widget to purchase new up-to-date equipment at a cost of $330,785. This new equipment would have an expected useful life of 7 years and result in an annual tax savings of $2,150 (a cash inflow). At the end of its 7 year useful life, it is estimated the equipment can be sold for $175,000. Option Three: Another equipment manufacturer has provided a proposal offering to supply a competing. Under this proposal, Widget would purchase the equipment for $225,000. This equipment has a 7 year useful life and an estimate $95,000 useful life with an annual tax savings (a cash inflow) of $1,500. Additional Information: ï‚· In order to accommodate any of the equipment options, Widget would need to upgrade the electrical supply capacity and the floor supports in the manufacturing building. The work would be accomplished using Widget's maintenance department at an estimated cost of $328,000. ï‚· Based on your discussions with the Maintenance Department supervisor, it is estimated that annual maintenance costs would be $25,000, $15,000 and $10,000 for the three options respectively. ï‚· The Production Department supervisor was quite excited about either upgrading their existing equipment or purchasing replacement equipment. The supervisor estimates that the upgrade to the new equipment would reduce labor cost by $1,500 for option 1, $5,000 for option 2 and $7,500 for option 3. ï‚· The Sales Manager provided estimates of the effect on sales revenue based on the lower prices Widget can charge due to the labor cost savings. She estimated revenue increases of $42,500, $50,000, and $32,000 for options 1, 2, and 3 respectively
Prepare a schedule of the relevant costs for each option and the timing of the relevant cash flows, use these schedules as input for your analysis. Include in your analysis a schedule showing the annual cash inflows/outflows for each option and the net present value of each option (NPV function). Assume Widget can invest its money at a 7% annual interest rate and expects all capital projects to return this rate at a minimum. Also assume that all cash flows, including payments, occur at the end of the year.