Question

The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation is currently done largely by hand. The machine the company is considering costs $160,000. 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 $10,800, including installation. After five years, the machine could be sold for $5,000.

The company estimates that the cost to operate the machine will be $8,800 per year. The present method of dipping chocolates costs $48,000 per year. In addition to reducing costs, the new machine will increase production by 4,000 boxes of chocolates per year. The company realizes a contribution margin of $1.40 per box. A 18% 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. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places and intermediate calculations to nearest dollar amount.)

     

Answer 1

1
Reduction in annual operating costs:
Operating costs, present hand method	48000
Operating costs, new machine	8800
Annual savings in operating costs	39200
Increased annual contribution margin	5600	=4000*1.4
Total annual net cash inflows	44800
2
	Now	1	2	3	4	5
Purchase of machine	-160000
Annual net cash inflows		44800	44800	44800	44800	44800
Replacement parts				-10800
Salvage value of machine						5000
Total cash flows	-160000	44800	44800	34000	44800	49800
Discount factor	1	0.847	0.718	0.609	0.516	0.437
Present value	-160000	37946	32166	20706	23117	21763
Net present value	-24302