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 $260,000. 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 $10,700, including installation. After five years, the machine could be sold for $10,000.

The company estimates that the cost to operate the machine will be $8,700 per year. The present method of dipping chocolates costs $47,000 per year. In addition to reducing costs, the new machine will increase production by 9,000 boxes of chocolates per year. The company realizes a contribution margin of $1.70 per box. A 16% rate of return is required on all investments.

Click here to view Exhibit 13B-1 and Exhibit 13B-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

All figures are in $

Ans1. Annual net cash inflows that will be provided by the new machine will be as under

Increase in contribution = 9000*1.7 = 15300

Saving in cost = 47000

Less: Cost for operating machine = 8700

Less: Depreciation for 1st year(260000-10000)/5 = 50000

Net Cash inflow = 3600

Ans2. New machine's net present value is

Today's Cost is = 260000

Less: Scrap value present value(10000*.862) = 8620

Net Present value of New Machine = 251380

we should also keep in mind the cost which we have to incur at the end of 3rd year for maintaning machine's life upto 5 years and alternatively we can take present value of that cost also.