Question

Krautco is thinking of buying a new cabbage shredder with a cost of 10,000. It has a 5 year life and is depreciated by straight line method. The machine will make 2000 cases per year with each case costing $2 to make and priced at $5. Assume the discount rate is 17% and the tax rate is 34%. Should Krautco make the purchase?

Answer 1

To decide if Krautco should purchase the cabbage shredder, a capital budgeting analysis including Net Present Value or Internal Rate of Return calculations should be performed, taking into account the cost of production, revenue from sales, tax savings, and the discount rate.

Step-by-step explanation:

The question asks whether Krautco should purchase a new cabbage shredder based on given financial metrics such as initial cost, lifespan, production volume, cost per case, sales price per case, discount rate and tax rate. Using these inputs, one needs to perform capital budgeting analysis, typically using methods like Net Present Value (NPV) or Internal Rate of Return (IRR), to assess the profitability of the investment.

The depreciation of the shredder would be $2,000 per year ($10,000 cost divided by a 5-year life). To calculate the incremental cash flows, we would need to account for the revenue from selling 2000 cases at $5 each, less the cost of producing these cases at $2 each, and then factor in tax savings from depreciation. The discount rate provided would be used to discount these cash flows back to their present value. If the present value of these cash flows is positive and higher than the initial investment, the purchase would be financially beneficial to Krautco.