Reference no: EM131179444
Gamma Electronicscurrently processes food products with a machine it purchased several years ago. The machine, which originally cost $600,000, currently has a book value of $300,000. Gammais considering replacing the machine with a newer, more efficient one. The new machine will cost $800,000 and will require an additional $200,000 for delivery and installation. The new machine will also require Gamma to increase its investment in receivables and inventory by $80,000. The new machine will be depreciated on a straight-line basis over five years to a zero balance. Gamma expects to sell the existing machine for $400,000. Gamma's marginal tax rate is 38 percent and the discount rate for Vista is 12 percent.
If Gamma purchases the new machine, annual revenues are expected to increase by $125,000 and annual operating costs (exclusive of depreciation) are expected to decrease by $30,000. Annual revenue and operating costs are expected to remain constant at this new level over the five-year life of the project. After five years, the new machine will be completely depreciated and is expected to be sold for $100,000. (Assume that the existing unit is being depreciated at a rate of $60,000 per year.)
a) Determine the payback period for this project.
b) Using net present value recommend whether or not Gamma should purchase the new machine.
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