EnterTech has noticed a significant decrease in the profitability of
its line of portable CD players. The production manager believes that
the source of the trouble is old, inefficient equipment used to
manufacture the product. The issue raised, therefore, is whether
EnterTech should (1) buy new equipment at a cost of $120,000 or (2)
continue using its present equipment. It is unlikely that demand for
these portable CD players will extend beyond a five-year time horizon.
EnterTech estimates that both the new equipment and the present
equipment will have a remaining useful life of five years and no salvage
value. The new equipment is expected to produce annual cash savings in
manufacturing costs of $34,000, before taking into consideration
depreciation and taxes. However, management does not believe that the
use of new equipment will have any effect on sales volume. Thus, its
decision rests on the magnitude of the potential cost savings. The old
equipment has a book value of $100,000. However, it can be sold for only
$20,000 if it is replaced. EnterTech has an average tax rate of 40
percent and uses straight-line depreciation for tax purposes. The
company requires a minimum return of 12 percent on all investments in
a. Compute the net present value of the new machine using the tables in Exhibits 26–3 and 26–4.
b. What nonfinancial factors should EnterTech consider?
c. If the manager of EnterTech is uncertain about the accuracy of the
cost savings estimate, what actions could be taken to double-check the