Question

Use NPV to analyze the decision to purchase the new machine.

A) Identify and label each inflows/outflow, don't just present a single inflow/outflow number for each year.

B) Assuming a discount rate of 10%

C) Do not include financing costs (loan interest and principal repayments) they are incorporated into the discount rate. Assume an initial investment (cash outflow) equal to the cost of the new machine.

The new machine costs $140,000 and the straight line depreciation of 10 percent per annum and after five years they would sell it for $60,000. The seller offered to offered a fixed amount for maintenance starting at $2,000 in the first year and increase it by $1,000 each year.

The labor cost will be saved 10 percent of the existing reduction of 30/hour based on a 35 hour week in a 50 week year and then it will then increase a fixed 250 each year.

The electricity cost will save the company 10 percent of the existing reduction of 5.625 per hour, 24 hours a day, seven days a week in a 50 week year. This electricity saving would then increase by a fixed 75 each year.

Answer 1

Answer is given below

No tax rate is given in question. Hence solved without tax rate

It is assumed project period is for 5 years ( after 5 years machine is sold)

Year 1 Year 2 Year 3 Year 4 Year 5 -$140,000 $5,250 $4,725 $9,975 $5,500 $4,800 $10,300 $5,750 $4,875 $10,625 $6,000 $4,950 $10,950 $6,250 yearly increase of $250 $5,025 yearly increase of $75 $11,275 Cost of Machine Savings Labor cost Electricity cost Total savings Less: Maintenance changes Operating cash inflow Salvage value Total Cash inflows /(Outflows) Present value at 10% Present value of Cash flows $5,000 $2,000 $7,975 $3,000 $7,300 $4,000 $6,625 $5,950 -$140,000 1.0000 -$140,000 $7,975 0.9091 $7,250 $7,300 0.8264 $6,033 $6,625 0.7513 $4,977 $5,950 0.6830 $4,064 $6,000 $5,275 $60,000 $65,275 0.6209 $40,531 Net present value -$77,145 NPV is negative hence investment should not be made Working notes: $30.00 labor cost savings hourly rate weekly hours weeks in a year Total labor cost 10% savings $52,500 ($30*35*50) $5,250 $5.625 electricity cost savings hourly rate Daily hours Days in a week weeks in a year Electricity cost 10% savings $47,250 ($5.625*24*7*50) $4,725