Lasting Impressions (LI) Company is a medium-sized commercial printer

Lasting Impressions (LI) Company is a medium-sized commercial printer

Lasting Impressions (LI) Company is a medium-sized commercial printer of promotionaladvertising brochures, booklets, and other direct-mail pieces. The firm’smajor clients are ad agencies based in New York and Chicago. The typical job ischaracterized by high quality and production runs of more than 50,000 units. LI hasnot been able to compete effectively with larger printers because of its existing older,inefficient presses. The firm is currently having problems cost-effectively meeting runlength requirements as well as meeting quality standards.The general manager has proposed the purchase of one of two large, six-colorpresses designed for long, high-quality runs. The purchase of a new press wouldenable LI to reduce its cost of labor and therefore the price to the client, putting thefirm in a more competitive position. The key financial characteristics of the old pressand of the two proposed presses are summarized in what follows.Old press Originally purchased 3 years ago at an installed cost of $400,000, itis being depreciated under MACRS using a 5-year recovery period. The oldpress has a remaining economic life of 5 years. It can be sold today to net$420,000 before taxes; if it is retained, it can be sold to net $150,000 beforetaxes at the end of 5 years.Press A This highly automated press can be purchased for $830,000 and willrequire $40,000 in installation costs. It will be depreciated under MACRS usinga 5-year recovery period. At the end of the 5 years, the machine could be sold tonet $400,000 before taxes. If this machine is acquired, it is anticipated that thecurrent account changes shown in the following table would result.Press B This press is not as sophisticated as press A. It costs $640,000 andrequires $20,000 in installation costs. It will be depreciated under MACRSusing a 5-year recovery period. At the end of 5 years, it can be sold to net$330,000 before taxes. Acquisition of this press will have no effect on the firm’snet working capital investment.The firm estimates that its earnings before depreciation, interest, and taxes withthe old press and with press A or press B for each of the 5 years would be as shownin Table 1 (see page 504). The firm is subject to a 40% tax rate. The firm’s cost ofcapital, r, applicable to the proposed replacement is 14%.TO DOa. For each of the two proposed replacement presses, determine:(1) Initial investment.(2) Operating cash inflows. (Note: Be sure to consider the depreciation inyear 6.)(3) Terminal cash flow. (Note: This is at the end of year 5.)b. Using the data developed in part a, find and depict on a time line the relevant cash flow stream associated with each of the two proposed replacement presses,assuming that each is terminated at the end of 5 years.c. Using the data developed in part b, apply each of the following decision techniques:(1) Payback period. (Note: For year 5, use only the operating cash inflows—that is, exclude terminal cash flow—when making this calculation.)(2) Net present value (NPV).(3) Internal rate of return (IRR).d. Draw net present value profiles for the two replacement presses on the same setof axes, and discuss conflicting rankings of the two presses, if any, resulting fromuse of NPV and IRR decision techniques.e. Recommend which, if either, of the presses the firm should acquire if the firm has(1) unlimited funds or(2) capital rationing.f. What is the impact on your recommendation of the fact that the operating cashinflows associated with press A are characterized as very risky in contrast to thelow-risk operating cash inflows of press B?

 

 

 

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