Question

The production manager of Baristas Ltd is considering to add 3 coffee machines to cater the demands of their signature coffee brew items. The cost of the coffee machine is €2,000 each. The supplier will charge a one-off installation cost of €100. The machines have a 5 year economic life with no salvage value. The machines will increase their annual revenues by €1000 with the total costs of operating the new machines of €350 annually. The production manager has a budget of $7,000 for investment. The financial manager stated that the company’s WACC is 14%.

Ques tion:

1. Calculate the initial cashflow for the machines!

2. Calculate the annual incremental cashflow in year 1 to 5!

3. Will Barista Ltd invest in the new coffee machines? (based your answer on at least 2 of

   the following: NPV, PI, IRR, Modified payback period)

Answer 1

Initial cashflows = No fo machines * ( Purchase price of the machine + installation cost )

= 3 * ( 2000 + 100 ) = 6300

Annual incremental cashflows in year 1 to 5 = 1000 -350 = 650

As there is no tax rate mentioned hence we have ignored the depreciation tax shield.

Net Present value of machine = Casflows * [ 1 - ( 1+ wacc )^- no of years ] / wacc - initial investment

= {650 * [ 1 - 1.14^-5 ] / 0.14}*3 - 6300

= 6694.51 - 6300 = 394.51

PI = Present value of cash inflows / Initial investmnet = 6694.51 / 6300 = 1.063

On the basis of PI and NPV the project should be accepted.