Solved: Pro Chips is a manufacturer of prototype chips

based in

Pro Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2013, Pro
Chips expects to deliver 552 prototype chips at an average price of $80,000. Pro Chips'
marketing vice president forecasts growth of 60 prototype chips per year through 2019. That is,
demand will be 552 in 2013, 612 in 2014, 672 in 2015, and so on.

The plant cannot produce more than 540 prototype chips annually. To meet future demand, Pro
Chips must either modernize the plant or replace it. The old equipment is fully depreciated and
can be sold for $3,600,000 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:

Pro Chips uses straight-line depreciation, assuming zero terminal disposal value. For simpli city,
we assume no change in prices or costs in future years. The investment will be made at the
beginning of 2013, and all transactions thereafter occur on the last day of the year. Pro Chips'
required rate of return is 12%.

There is no difference between the modernize and replace alternatives in terms of required
working capital. Pro Chips has a special waiver on income taxes until 2019.

REQUIRED

1. Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2013
to 2019 period.

2. Calculate payback period for the modernize and replace alternatives.

3. Calculate net present value of the modernize and replace alternatives.

4. What factors should Pro Chips consider in choosing between the alternatives?

Pro Chips is a manufacturer of prototype chips based in

ANSWER
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