Question

The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation currently is done largely by hand. The machine the company is considering costs $230,000. The manufacturer estimates that the machine would be usable for five years but would require the replacement of several key parts at the end of the third year. These parts would cost $11,500, including installation. After five years, the machine could be sold for $8,000.

The company estimates that the cost to operate the machine will be $9,500 per year. The present method of dipping chocolates costs $55,000 per year. In addition to reducing costs, the new machine will increase production by 7,000 boxes of chocolates per year. The company realizes a contribution margin of $1.75 per box. A 13% rate of return is required on all investments.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. What are the annual net cash inflows that will be provided by the new dipping machine?

2. Compute the new machine’s net present value.

Answer 1

	Year	0	1	2	3	4	5
	cost of machine	-230000
	Saving from operating cost =55000-9500		45500	45500	45500	45500	45500
	contribution margin from additional unit of sale =7000*1.75		12250	12250	12250	12250	12250
	replacement of parts				-11500
	scrap value of machine						8000
	net operating annual cash flow	-230000	57750	57750	46250	57750	57750
1-	present value of net operating cash flow = net operating cash flow/(1+r)^n r = 13%	-230000	51106.1947	45226.721	32053.57001	35419.15652	31344.3863
2-	Net present value = sum of present value of cash flow	-34849.9715