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 $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 $9,300, including installation. After five years, the machine could be sold for $4,000.

The company estimates that the cost to operate the machine will be $7,300 per year. The present method of dipping chocolates costs $33,000 per year. In addition to reducing costs, the new machine will increase production by 2,000 boxes of chocolates per year. The company realizes a contribution margin of $1.00 per box. A 16% rate of return is required on all investments.

Click here to view Exhibit 13B-1 and Exhibit 13B-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

Solution 1:

Computation of net annual cash inflows by new dipping machine - Sweetwater Candy Company
Particulars	Amount
Annual saving in operating cost ($33,000 - $7,300)	$25,700.00
Contribution margin from additional quantity produced (2000*$1.00)	$2,000.00
Net Annual cash inflows	$27,700.00

Solution 2:

Computation of NPV
Particulars	Period	Amount	PV Factor	Present Value
Cash outflows:
Cost of machine	0	$1,20,000	1	$1,20,000
Cost of replaced parts	3	$9,300	0.641	$5,961
Present value of cash outflows (A)				$1,25,961
Cash Inflows:
Annual cash inflows	1-5	$27,700.00	3.274	$90,690
Salvage value	5	$4,000	0.476	$1,904
Present value of cash inflow (B)				$92,594
NPV (B-A)				-$33,368

Net present value = - $33,368