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 $10,400, including installation. After five years, the machine could be sold for $7,500.

The company estimates that the cost to operate the machine will be $8,400 per year. The present method of dipping chocolates costs $44,000 per year. In addition to reducing costs, the new machine will increase production by 6,000 boxes of chocolates per year. The company realizes a contribution margin of $1.55 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

1
Reduction in annual operating costs:
Operating costs, present hand method	44000
Operating costs, new machine	8400
Annual savings in operating costs	35600
Increased annual contribution margin	9300	=6000*1.55
Total annual net cash inflows	44900
2
	Now	1	2	3	4	5
Purchase of machine	-230000
Annual net cash inflows		44900	44900	44900	44900	44900
Replacement of parts				-10400
Salvage value of the machine						7500
Total cash flows	-230000	44900	44900	34500	44900	52400
Discount factor (13%)	1	0.885	0.783	0.693	0.613	0.543
Present value	-230000	39737	35157	23909	27524	28453
Net present value	-75220