Case 1 Essay

283 Words2 Pages
Camus Blalack, process engineer, knows that the acceptance of a new process design will depend on its economic feasibility. The new process is designed to improve environmental performance. On the negative side, the process design requires new equipment and an infusion of working capital. The equipment will cost $300,000, and its cash operating expenses will total $60,000 per year. The equipment will last for seven years but will need a major overhaul costing $30,000 at the end of the fifth year. At the end of seven years, the equipment will be sold for $24,000. An increase in working capital totaling $30,000 will also be needed at the beginning. This will be recovered at the end of the seven years. On the positive side, Camus estimates that the new process will save $135,000 per year in environmental costs (fines and cleanup costs avoided). The cost of capital is 10 percent. Required: 1. Prepare a schedule of cash flows for the proposed project. Assume that there are no income taxes. 2. Compute the NPVof the project. Should the new process design be accepted? SOLUTION 1. Schedule of cash flows: Year Item Cash Flow 0 Equipment $(300,000) Working capital (30,000) 1–7 Cost savings $135,000 Equipment operating costs (60,000) 75,000 5 Overhaul (30,000) 7 Salvage value 24,000 Recovery of working capital 30,000 2. NPV: Year Cash Flow Discount Factor Present Value 0 $(330,000) 1.00000 $(330,000) 1–7 75,000 4.86842 365,132 5 (30,000) 0.62092 (18,628) 7 54,000 0.51316 27,711 NPV $ 44,215 Yes, the new process design should be

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