Eddison Electronic Company (EEC) provides electricity for several states in the United States. You have been employed as a cost accountant at this organization. The Operations department is thinking about making a capital investment this current year. Prepare a memo to the VP of Accounting at EEC that answers the questions below based on the following criteria:
- EEC expects to save $500,000 per year for the next 10 years by purchasing the supplier.
- EEC’s cost of capital is 14%.
- EEC believes it can purchase the supplier for $2 million.
In your memo to the VP of Accounting, answer the following questions:
- What are the advantageous and disadvantages to each investing method (NPV, IRR, or payback period)?
- Which of the methods (NPV, IRR, or payback period) should EEC use, and why?
- Would your answer be the same if EEC’s cost of capital were 25%? Why or why not?
- Would your answer be the same if EEC did not save $500,000 per year as anticipated?
- What would be the least amount of savings that would make this investment attractive to EEC?
- Based on your calculations, should EEC acquire the supplier? Why or why not?