Question

Net Present Value Method and Present Value Index

Diamond and Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 130 baseballs per hour to sewing 234 per hour. The contribution margin per unit is $0.44 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $24 per hour. The sewing machine will cost $182,600, have a five-year life, and will operate for 1,400 hours per year. The packing machine will cost $79,200, have a five-year life, and will operate for 1,200 hours per year. Diamond and Turf seeks a minimum rate of return of 15% on its investments.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

a. Determine the net present value for the two machines. Use the table of present values of an annuity of $1 above. Round to the nearest dollar.

	Sewing Machine	Packing Machine
Present value of annual net cash flows	$	$
Amount to be invested	$	$
Net present value	$	$

b. Determine the present value index for the two machines. If required, round your answers to two decimal places.

	Sewing Machine	Packing Machine
Present value index

c. If Diamond and Turf has sufficient funds for only one of the machines and qualitative factors are equal between the two machines, in which machine should it invest?

Answer 1

Answer a & b.

Diamond & Turf Inc.

Year PV Annuity Factor - 15% Sewing Machine Packing Machine

Amount PV Amount Amount PV Amount

Present value of annual net cash flows (A)

Increase in Contribution Per Year

= $0.44 X 104 Balls X 1400 hrs 1-5 3.353 64,064 214,807

Labour Cost Saved

= $24 X 1,200 hrs 1-5 3.353 28,800 96,566

Less amount to be invested (B)

Cost of Machine 0 1 182,600 182,600 79,200 79,200

Net present value 32,207 17,366

Present Value Index (A/B) 1.18 1.22

Answer c.

Imvest in Packing Machine, since its Present Value Index is higher than Sewing Machine.