Question

“I’m not sure we should lay out $365,000 for that automated welding machine,” said Jim Alder, president of the Superior Equipment Company. “That’s a lot of money, and it would cost us $97,000 for software and installation, and another $5,300 every month just to maintain the thing. In addition, the manufacturer admits that it would cost $60,000 more at the end of three years to replace worn-out parts.”

     “I admit it’s a lot of money,” said Franci Rogers, the controller. “But you know the turnover problem we’ve had with the welding crew. This machine would replace six welders at a cost savings of $127,000 per year. And we would save another $8,800 per year in reduced material waste. When you figure that the automated welder would last for six years, I’m sure the return would be greater than our 15% required rate of return.”

     “I’m still not convinced,” countered Mr. Alder. “We can only get $23,500 scrap value out of our old welding equipment if we sell it now, and in six years the new machine will only be worth $43,000 for parts. But have your people work up the figures and we’ll talk about them at the executive committee meeting tomorrow.”

Required

 1. Compute the annual net cost savings promised by the automated welding machine. 

 2a. Using the data from (1) above and other data from the problem, compute the automated welding machine's net present value

 2b. Would you recommend purchasing the automated welding machine? 

 3. Assu that management can identify several intangible benefits associated with the automated me welding machine, including greater flexibility in shifting from one type of product to another, improved quality of output, and faster delivery as a result of reduced throughput time. What minimum dollar value per year would management have to attach to these intangible benefits in order to make the new welding machine an acceptable investment? 

Answer 1

1
	Reduction in labour Cost	127000
	Reductio in material waste	8800
	Total	135800
	Less: InCREASEd material cost	63600	(5300*12)
	Annual net saving	72200
2		Now	1	2	3	4	5	6
	Cost of Machine	-365000
	Software installation	-97000
	Salvage of old equipment	23500
	Annual Cost saving		72200	72200	72200	72200	72200	72200
	Replacement of parts				-60000
	Salvage value of new machine							43000
	Total cash flow	-438500	72200	72200	12200	72200	72200	115200
	Discount factor@15%	1.0000	0.8696	0.7561	0.6575	0.5718	0.4972	0.4323
	Present Value	$   (438,500.00)	$        62,782.61	$ 54,593.57	$ 8,021.70	$ 41,280.58	$ 35,896.16	$ 49,804.14
	NPV	$   (186,121.24)
2b	No
3	Numerator	Denominator	Intangible benefit
	186121	3.7845	$        49,180.04