Evaluate The Capital Investment Scenarios For Shoals Corpora

Evaluate The Capital InvestmentScenarioshoals Corporation Put

Project: Evaluate the Capital Investment Scenario Shoals Corporation puts significant emphasis on cash flow when planning capital investments. The company chose its discount rate of 8 percent based on the rate of return it must pay its owners and creditors. Using that rate, Shoals Corporation then uses different methods to determine the most appropriate capital outlays. This year, Shoals Corporation is considering buying five new backhoes to replace the backhoes it now owns. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them.

The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes. The following information is available to use in deciding whether to purchase the new backhoes:

• Old Backhoes:
  • Purchase cost when new: $90,000
  • Salvage value now: $42,000
  • Remaining life: 8 years
  • Net cash flow generated each year: $30,425
  • Investment in major overhaul needed next year: $55,000
  • Salvage value in 8 years: $15,000
• New Backhoes:
  • Purchase cost when new: $200,000
  • Salvage value in 8 years: $90,000
  • Remaining life: 8 years
  • Net cash flow generated each year: $43,900

Paper For Above instruction

In this analysis, we assess whether Shoals Corporation should purchase new backhoes or overhaul the existing ones by examining the financial implications of each option through methods such as net present value (NPV), payback period, and profitability index. We also consider intangible benefits that might influence the decision and provide a comprehensive recommendation based on the findings.

Evaluation of Investment Options

Initial investment calculations are fundamental to this analysis. For the old backhoes, the investment is the cost of overhaul, which is $55,000. Since the current salvage value of the old backhoes is $42,000, we consider the old asset’s net book value, but for simplicity in cash flow analysis, the major overhaul expenditure is treated as an initial outlay, with subsequent cash flows evaluated over the remaining 8 years.

For the new backhoes, the initial investment accounts for the purchase price minus the old salvage value, resulting in an outlay of $200,000 - $42,000 = $158,000, considering the salvage value of the old equipment as a recovery of part of the investment.

Net Present Value Analysis

The NPV of each investment option depends on the annual cash flows, discount rate (8%), and the project's lifespan. Using the NPV formula, we evaluate both options.

The NPV of the old backhoes (considering the overhaul and cash inflows) involves calculating the present value of annual net cash flows ($30,425) over 8 years, minus the initial overhaul cost ($55,000). Similarly, for the new backhoes, the present value of $43,900 annual cash flows over 8 years is calculated against the initial purchase cost of $158,000.

Based on the calculations, the NPV for the old backhoes, including the overhaul, appears favorable if the present value of cash flows exceeds the investment, suggesting continued use might be justified if the NPV remains positive. Conversely, the new backhoes’ higher cash flows and salvage value aim to produce a higher NPV, indicating better long-term profitability for the company.

Payback Period Evaluation

The payback period measures how quickly the initial investment is recovered through cash inflows. For the old backhoes with overhaul costs of $55,000 and annual cash flows of $30,425, the payback occurs in approximately 1.8 years ($55,000 / $30,425). For the new backhoes, with an initial outlay of $158,000 and annual cash flows of $43,900, the payback period is around 3.6 years ($158,000 / $43,900).

This analysis indicates that the old backhoes recover their investment faster, but the overall profitability should also be weighed alongside cash flow benefits and potential savings from less maintenance and better efficiency with new equipment.

Profitability Index

The profitability index (PI) is calculated by dividing the present value of future cash flows by the initial investment. A PI greater than 1 suggests that the investment is profitable. For the old backhoes, the PI might be slightly less than 1 if the present value of cash flows and salvage value just offset the overhaul cost. For the new backhoes, the higher cash flows and salvage value increase the PI, indicating a potentially more attractive investment.

Intangible Benefits and Considerations

Beyond explicit financial metrics, intangible benefits such as improved operator comfort, increased trenching accuracy, reduced maintenance needs, and potential safety enhancements add value to the new backhoes. Training requirements for operators and the acceptance of new technology are also factors influencing the decision. These benefits may lead to increased productivity, fewer accidents, and higher employee satisfaction, all of which enhance the overall value of investing in new equipment.

Final Recommendation

Considering the financial analyses, the new backhoes offer a higher potential for long-term profitability, improved operational efficiency, and intangible benefits that could outweigh the higher initial cost. Although the old backhoes present a lower payback period, the ongoing maintenance and potential productivity challenges diminish their attractiveness.

Therefore, based on comprehensive evaluation—merging financial metrics with qualitative benefits—Shoals Corporation should consider purchasing the new backhoes. This decision aligns with strategic goals of operational excellence and long-term sustainability.

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