Responsible Testing Company may buy DNA‐testing equipment A costing $60,000 now (at year 0). This equipment is expected to reduce labor costs of the clinical staff, net of all staff training expenditures, by $20,000 annually in the subsequent years following the investment. Equipment A has a useful life of 8 years and can be straight‐line‐depreciated over its years of operations. No salvage value is expected at the end. The corporate tax rate (combined federal and state) is 40% and the company’s required rate‐of‐return is 15%.
Questions 2 – Capital budgeting and NPV
Responsible Testing Company may buy DNA‐testing equipment A costing $60,000 now (at year 0).
This equipment is expected to reduce labor costs of the clinical staff, net of all staff training
expenditures, by $20,000 annually in the subsequent years following the investment. Equipment
A has a useful life of 8 years and can be straight‐line‐
salvage value is expected at the end. The corporate tax rate (combined federal and state) is 40%
and the company’s required rate‐of‐return is 15%.
(2a) Describe the company’s “investment project”. Calculate the relevant cash flows and use the
NPV method to determine the attractiveness of this project.
(2b) Suppose that in the second year (year 2) a more efficient and effective DNA‐testing
equipment B is expected to enter the market. The new equipment costs $90,000, will have an
effective operating life of 6 years, can be straight‐line‐depreciated but can save the company
$35,000 annually. Help the company decide between (i) purchasing equipment A now, operating
and enjoying the savings for 8 years, and (ii) waiting until year 2 before purchasing equipment B,
operating and realizing the savings for the subsequent 6 years
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