21-34 Equipment replacement, no income taxes. Dublin Chips is a manufacturer of prototype chips based in
Dublin, Ireland. Next year, in 2018, Dublin Chips expects to deliver 615 prototype chips at an average price of
$95,000. Dublin Chips’ marketing vice president forecasts growth of 65 prototype chips per year through 2024.
That is, demand will be 615 in 2018, 680 in 2019, 745 in 2020, and so on.
The plant cannot produce more than 585 prototype chips annually. To meet future demand, Dublin Chips
must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for
$4.200,000 if the plant is replaced. If the plant is modernized, the costs to modernize it are to be capitalized and
depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize
alternative. The following data on the two options are available:
Initial investment in 2018
Terminal disposal value in 2024
Total annual cash operating costs per prototype chip
Dublin Chips uses straight-line depreciation, assuming zero terminal disposal value. For simplicity, we assume
no change in prices or costs in future years. The investment will be made at the beginning of 2018, and all
transactions thereafter occur on the last day of the year. Dublin Chips’ required rate of return is 14%.
There is no difference between the modernize and replace alternatives in terms of required working capital.
Dublin Chips has a special waiver on income taxes until 2024.
1. Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2018-2024 period.
2. Calculate the payback period for the modernize and replace alternatives.
3. Calculate net present value of the modernize and replace alternatives.
4. What factors should Dublin Chips consider in choosing between the alternatives?Managerial Accounting