Question

The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation is currently done largely by hand. The machine the company is considering costs $210,000. 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 $11,300, including installation. After five years, the machine could be sold for $6,000.

      The company estimates that the cost to operate the machine will be $9,300 per year. The present method of dipping chocolates costs $53,000 per year. In addition to reducing costs, the new machine will increase production by 5,000 boxes of chocolates per year. The company realizes a contribution margin of $1.65 per box. A 19% rate of return is required on all investments.

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

Reduction in annual operating costs:
Operating costs, present hand method
Operating costs, new machine
Annual savings in operating costs	0
Increased annual contribution margin
Total annual net cash inflows	$0

	Now	1	2	3	4	5
Purchase of machine
Annual net cash inflows
Replacement parts
Salvage value of machine
Total cash flows	$0	$0	$0	$0	$0	$0
Discount factor (19%)
Present value	0	0	0	0	0	0
Net present value	$0

Answer 1

Reduction in annual operating costs:
Operating costs, present hand method	53000
Operating costs, new machine	9300
Annual savings in operating costs	43700
Increased annual contribution margin	8250	=5000*1.65
Total annual net cash inflows	51950
2
	Now	1	2	3	4	5
Purchase of machine	-210000
Annual net cash inflows		51950	51950	51950	51950	51950
Replacement parts				-11300
Salvage value of machine						6000
Total cash flows	($210,000)	$51,950	$51,950	$40,650	$51,950	$57,950
Discount factor (19%)	1	0.84	0.706	0.593	0.499	0.419
Present value	($210,000)	$43,638	$36,677	$24,105	$25,923	$24,281
Net present value	($55,376)