Waterways of the United Kingdom: Canals, Rivers, Lakes & More

The Net Present Values 

Keep Old Backhoes 

Net Present Value of Keeping the Old Backhoes
Event	Time Period	Cash Flow	8% Discount Factor	Present Value
Net Annual Cash Flow	1 to 8	$30,425	5.74664	$174,841.52
Salvage value in 8 years	8	$15,000	0.54027	$8,104.05
				$182,945.57
Deduct Initial Investment (Cost of overhaul)	1	$55,000	0.92593	$50,926.15
Net Present Value				$132,019.42

The 8% discount factors are obtained from tables 3 and 4 of Appendix G (Weygandt et al., 2018). 

The PVs of the net annual cash flows are summed with the PV of the salvage value in 8 years. The summation is then lessened by the PV of the initial investment (cost of the overhaul next year) to obtain the NPV as: 

NPV =$132,019.42 

Buy New Backhoes 

Net Present Value of Buying New Backhoes
Event	Time Period	Cash Flow	8% Discount Factor	Present Value
Net Annual Cash Flow	1 to 8 years	$43,900	5.74664	$252,277.50
Salvage value in 8 Years	8	$90,000	0.54027	$48,624.30
				$300,901.80
Purchase cost when new	0	$200,000	1	$200,000
Current Salvage value of old equipment	0	$42,000	1	$42,000
Initial Investment				$158,000
Net Present Value				$142,901.80

The 8% discount factors are obtained from tables 3 and 4 of Appendix G (Weygandt et al., 2018). 

The PVs of the net annual cash flows are summed with the PV of the salvage value in 8 years. The new backhoes’ initial investment is obtained by subtracting the old equipment’s current salvage value from the new backhoes’ purchase cost. The NPV is obtained by subtracting the initial investment from the summation of the PVs of the net annual cash flows and the salvage value in 8 years as: 

NPV= $ 142,901.80 

The purchase of new backhoes presents a higher NPV, $142,901.80, than the retention of the old ones, $132,019.42. A high positive NPV is indicative of the desirability of an investment. Consequently, the purchase of new backhoes is a more attractive investment than retaining the old ones. 

Payback Method 

Keep Old Backhoes 

The payback of the old backhoes is determined by dividing the cost of the overhaul in the next one year by the net cash flow per year 

Payback period =  Payback period =  = 1.8077 ≈ 1.81 Years 

Buy New Backhoes The initial investment is obtained by subtracting the current salvage value of the old equipment from the purchase cost of the new backhoes 

Payback period =  Payback period =  = 3.599 ≈ 3.6 Years 

The retention of the old backhoes has a shorter payback period, 1.81 years, than the purchase of new ones, 3.6 years. Consequently, the retention of the old backhoes project is more desirable than the purchase of new ones since the shorter repayment period is indicative of lesser risks in terms of the changes in economic conditions. 

Profitability Index 

Keep Old Backhoes 

Profitability Index = 

The net cash flows are inclusive of the present value of the salvage value. From Question 1, the summation of the PVs of the cash flows and the salvage value is 

$182,945.57 

The initial investment is $55, 000 

Profitability Index =  = 3.3264 ≈ 3.3 

Buy New Backhoes 

PV of net cash flows from question 1 = $300,901.80 

The new backhoes’ initial investment is obtained by subtracting the old equipment’s current salvage value from the new backhoes’ purchase cost. 

Profitability Index =  = 1.9044 ≈ 1.9 

The profitability of the old backhoes, 3.3, exceeds that of the new ones, 1.9. Consequently, the retention of the old backhoes is more desirable than the purchase of new ones. 

Internal Rate of Return 

Keep old Backhoes 

Since the net annual cash flows are equal, the internal rate of return is calculated using the formula: 

Internal rate of return factor = 

Internal rate of return factor =  = 1.80772 

The IRR factor of 1.80772 is used to check for the IRR from Table 4 of Appendix G (Weygandt et al., 2018) . The 8-year payment row is used to check for the IRR. The table ends at 4.48732 for the 15% IRR indicating that the IRR, in this case, is greater than 15%. The IRR is calculated using a financial calculator as 53.526% 

Buy New Backhoes 

Internal rate of return factor =  = 3.59909 

The IRR factor of 3.59909 is used to check for the IRR from Table 4 of Appendix G (Weygandt et al., 2018) . The table ends at 4.48732 for the 15% IRR indicating that the IRR, in this case, is greater than 15%. The IRR is calculated using a financial calculator as 22.195% 

Both the retention of the old backhoes and the purchase of new ones are acceptable projects since their IRRs are greater than the required rate of return (8%). However, the old backhoes’ retention is more acceptable than the purchase of new ones since its IRR, 53.526%, is greater than that of new backhoes, 22.195%. 

Intangible benefits or Negatives 

Some of the intangible benefits not included in the capital budgeting techniques include the backhoes’ speed, trench digging accuracy, and comfort features. The new backhoes are faster than the old ones; thus, their purchase would lead to faster task completion. Besides, the purchase of the new backhoes would lead to increased accuracy in trench digging. The new backhoes would also present the additional benefit of comfort features to the operators. 

Some of the negatives associated with purchasing the new backhoes include the time required to train the operators on their use and possible resistance from the operators. The operators are accustomed to the old backhoes; thus, they may resist using the new backhoes. 

Decision 

The decision on the most desirable project is a difficult one. Both projects have their advantages. The purchase of the new backhoes has a higher NPV than the retention of the old ones. The purchase of the new equipment also presents some benefits, including speed, comfortability, and accuracy. The maintenance costs for the new backhoes are also low. 

According to the payback period, IRR method, and profitability index, the retention of the old backhoes is more desirable than the purchase of the new ones. Although the old backhoes’ maintenance costs will be high, its initial investment is lower than the purchase of new ones. Since financial resources are often limited, I would choose to retain the old backhoes as it does not require a high initial investment. Besides, its short payback period indicates fewer financial risks in recouping the investment costs. It also has a higher profitability index than the purchase of new backhoes. 

References 

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018).  Accounting principles  (13th ed.). John Wiley & Sons.