Question

Problem 12-22 Net Present Value Analysis [LO12-2]

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 $120,000. 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 $9,000, 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 $7,000 per year. The present method of dipping chocolates costs $30,000 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 $1.50 per box. A 20% rate of return is required on all investments.

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

B2 X for 1 increase in production (units) contribution margin per unit increase contribution margin savings in annual operating costs annual net cash inflows 6,000 $ 1.50 $9,000 $ 23,000 $ 32,000 + total net cash flows present value factor @ 20% present value of net cash flows year 0 $ 120,000 1.000 $ 120,000 year 1 $32,000 0.833 $ 26,656 year 2 $32,000 0.694 $ 22,208 year 3 $23,000 0.579 $ 13,317 year4 $32,000 0.482 $ 15,424 year 5 $ 39,500 0.402 $ 15,879 -$ 26,516 new machine's net present value -$ 26,516

for formulas and calculations, refer to the image below -

X fc 100% E F G H I increase in production (units) 6000 contribution margin per unit 1.5 increase contribution margin =E2*E3 savings in annual operating costs |=30000-7000 annual net cash inflows =E4+E5 total year 0 net cash flows - 120000 present value factor @ 20% present value of net cash flows =E9*E10 year 1 year 2 year 3 year 4 year 5 32000 32000 32000-9000 32000 32000+7500 0.833 0.694 0.579 0.482 0.402 =F9*F10 =G9*G10 =H9*H10 =19*110 =39*J10 =SUM(E11:J11) new machine's net present value =K11

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