Question

Net Present Value Methodand Present Value Index

Diamond and Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 170 baseballs per hour to sewing 306 per hour. The contribution margin per unit is $0.5 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 $392,600, have an eight-year life, and will operate for 1,400 hours per year. The packing machine will cost $117,300, have an eight-year life, and will operate for 1,200 hours per year. Diamond and Turf seeks a minimum rate of return of 12% 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? (If both present value indexes are the same, either machine will grade as correct.)

Answer 1

a
	Sewing Machine	Packing Machine
Present value of annual net cash flows	472954	143078
Amount to be invested	392600	117300
Net present value	80354	25778
b	Sewing Machine	Packing Machine
Present value index	1.20	1.22
c
Packing Machine should be selected
Workings:
Annual cash flows Sewing Machine = (306-170)*0.50*1400= $95200
Annual cash flows Packing Machine = 24*1200= $28800
	Sewing Machine	Packing Machine
Annual cash flows	95200	28800
X PV factor @ 12%	4.968	4.968
Present value of annual net cash flows	472954	143078
Present value of annual net cash flows	472954	143078
Divided by Amount to be invested	392600	117300
Present value index	1.20	1.22