Comprehensive Capital Budgeting Problem
Van Doren Corporation is considering producing a new temperature regulator called Digidial. Marketing data indicate that the company will be able to sell 45,000 units per year at $30. The product will be produced in a section of an existing factory that is currently not in use.
To produce Digidial, Van Doren must buy a machine that costs $500,000. The machine has an expected life of 6 years and will have an ending residual value of $15,000. Van Doren will depreciate the machine over 6 years using the straight-line method for both tax and financial reporting purposes.
In addition to the cost of the machine, the company will incur incremental manufacturing costs of $370,000 for component parts, $425,000 for direct labor, and $200,000 of miscellaneous costs. Also, the company plans to spend $150,000 annually to advertise Digidial. Van Doren has a tax rate of 40 percent, and the company’s required rate of return is 15 percent.
Compute the net present value.
Compute the payback period.
Compute the accounting rate of return.
Should Van Doren make the investment required to produce Digidial?