Question

Stirling Windows Inc. of Hong Kong is considering purchasing an automated cutting machine for use in the production of its stained-glass windows. The machine would cost $950,000. (All currency amounts are in Hong Kong dollars.) An additional $700,000 would be required for installation costs and for software. Management believes that the automated machine would provide substantial annual reductions in costs, as shown below:

	Annual Reduction in Costs
Labour Costs	$290,000
Material Costs	$93,000

The new machine would require considerable maintenance work to keep it in proper adjustment. The company’s engineers estimate that maintenance costs would increase by $5,260 per month if the machine were purchased. In addition, the machine would require a $93,000 overhaul at the end of the sixth year.

The new cutting machine would be usable for ten years, after which it would be sold for its scrap value of $200,000. It would replace an old cutting machine that can be sold now for its scrap value of $85,000. Stirling Windows requires a return of at least 18% on investments of this type. (Ignore income taxes.) Required: Question 1 a) Compute the net annual cost savings promised by the new cutting machine. Annual Net Cost Savings b) Using the data from requirement 1 above and other data from the problem, compute the new machine’s net present value. (Use the incremental-cost approach.) (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Do not round intermediate calculations and round your final answer to the nearest dollar amount. Negative amount should be indicated by a minus sign.) Net present value c) Would you recommend that the machine be purchased? Yes or No d) Assume that management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of stained-glass window to another, improved quality of output, and faster delivery as a result of reduced throughput time. What dollar value per year would management have to attach to these intangible benefits in order to make the new cutting machine an acceptable investment? (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Do not round intermediate calculations and round your final answer to the nearest dollar amount.) Intangible benefits per year Thank you!

Answer 1

Answer:

1.) Calculation Annual Net Cost savings

Annual Net Cost Savings = [(Labor costs + Material costs)-Additional Maintenance costs]
=[($290000+$93000)-($5260 x 12)]
=[$383000-$63120]
=$319880

2-a.) Calculation of Net Present Value

Year	Cash Flows	FVIFA @ 18%	PV of Cash flows
0	-1735000 =-(950000+700000-85000)	1	-1735000
1	319880	1.1800	271084.75
2	319880	1.3924	229732.84
3	319880	1.6430	194692.64
4	319880	1.9388	164988.65
5	319880	2.2878	139819.91
6	226880 =319880-93000	2.6996	84042.08
7	319880	3.1855	100417.52
8	319880	3.7589	85099.36
9	319880	4.4355	72118.14
10	519880 =319880+200000	5.2338	99331.27
Net Present Value			-293672.84

2-b)
No - Because the machine has a negative net present value of -$293672.84 If the machine purchased it will bring loss to the business. A machine with positive net present value can be purchased..

3.) Calculation of Intangible Benefits

Intangible Benefits = [Net present value/ (1-(1+r)^-n/r)]
=[$293672.84/(1-(1+18%)^-10/18%)]
=[$293672.84/(1-0.191064/18%)]
=[$293672.84/(0.808936/18%)]
=[$293672.84/4.494089]
=$65346.47 or 65346