A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods. The details for each option are provided below:
Option 1: $65,000 for equipment with a useful life of 7 years and no salvage value. Maintenance costs are expected to be $2,700 per year and increase by 3% in Year 6 and remain at that rate. Materials in Year 1 are estimated to be $15,000 but remain constant at $10,000 per year for the remaining years. Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after. Revenues are estimated to be:
Year 1: -75,000
Year 2: 100,000
Year 3: 125,000
Year 4: 150,000
Year 5: 150,000
Year 6: 150,000
Year 7: 150,000
Option 2: $85,000 for equipment with a useful life of 7 years and a $13,000 salvage value. Maintenance costs are expected to be $3,500 per year and increase by 3% in Year 6 and remain at that rate. Materials in Year 1 are estimated to be $20,000 but remain constant at $15,000 per year for the remaining years. Labor is estimated to start at $60,000 in Year 1, increasing by 3% each year after. Revenues are estimated to be:
Year 1: -80,000
Year 2: 95,000
Year 3: 130,000
Year 4: 140,000
Year 5: 150,000
Year 6: 160,000
Year 7: 160,000
The company's required rate of return and cost of capital is 8%. Management has turned to its finance and accounting department to perform analyses and make a recommendation on which option to choose. They have requested that the three main capital budgeting calculations be done: NPV, IRR, and Payback Period for each option.