Comfy Corporation manufactures furniture in several divisions, including the
patio furniture division. The manager of the patio furniture division plans to
retre in two years The manager receives a bonus based on the division's ROl,
which is currently \(7 \%\)
One of the machines that the patio furniture division uses to manufacture the
furniture is rather old and the manager must decide whether to replace it. The
new machine would cost \(\$ 35,000\) and would last 10 years. It would have no
salvage value. The old machine is fully depreciated and has no trade-in value.
Comfy uses straight-line depreciation for all assets. The new machine, being
new and more efficient, would save the company \(\$ 5,000\) per year in cash
operating costs. The only difference between cash flow and net income is
depreciation. The internal rate of return of the project is approximately $7
\%$. Comfy Corporation's's weighted-average cost of capital is 5\%. Comfy is
not subject to any income taxes.
1\. Should Comfy Corporation replace the machine? Why or why not?
2\. Assume that "investment" is defined as average net long-term assets (that
is, after depreciation) during the year. Compute the projects ROI for each of
its first five years. . If the patio furniture manager is interested in
maximizing his bonus, would he replace the machine before he retires? Why or
why not?
3\. What can Comfy do to entice the manager to replace the machine before
retiring?
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