Question

Net Present Value Method and Present Value Index Diamond and Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 170 baseballs per hour to sewing 306 per hour. The contribution margin per unit is $0.44 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $27 per hour. The sewing machine will cost $397,600, have a 10-year life, and will operate for 1,400 hours per year. The packing machine will cost $157,400, have a 10-year life, and will operate for 1,200 hours per year. Diamond and Turf seeks a minimum rate of return of 12% on its investments. Present Value of an Annuity of $1 at Compound Interest Year 6% 0.943 1.833 2.673 3.465 4.212 10% 0.909 1.736 2.487 3.170 3.791 4.355 4.868 12% 15% 20% 0.893 0.870 0.833 1.690 1.626 1.528 2.402 2.283 2.106 3.037 2.855 2.589 3.605 3.353 2.991 4.111 3.785 3.326 4.564 4.160 3.605 4.968 4.487 3.837 5.328 4.772 4.031 5.6505.0194.192 4.917 5.582 5.335 6.210 6.802 107.360 5.759 6.145

Answer 1

(1) Net present value is difference between present value of cash flow and initial investment. project with higher NPV is more profitable.

we will first prepare the cash flow table

sewing machine

additional balls stiched per hour [306-170]	136
increase in contribution margin per ball stiched	$0.44
increase in contribution margin per hour [136balls*0.44]	$59.84
hours per year	1400
increase in margin per year [59.84$*1400]	$83,776
useful years	10
PV factor of $1 compounded at 12% for 10years	5.650
present value of cash flows [83776*5.650]	$473,334

packing machine

Increase in contribution margin due to labor savings	$27 per hour
operating hours per year	1200
increase in contribution margin per year [27*1200]	$32,400
useful life	10 years
PV factor of $1 compounded at 12% for 10years	5.650
present value of annual cash flow [32400*5.650]	$183,060

	sewing machine	packing machine
present value of annual cash flow	$473,334	$183,060
amount to be invested	$397,600	$157,400
Net present value	$75,734[473334-397600]	$25,660[183060-157400]

sewing machine has a higher NPV it is better to invest in sewing machine

2. present value index= net present value/initial investment

	sewing machine	packing machine
present value index	0.16[75,734/473,334]	0.14[25,660/183,060]

if only one machine is to be selected than sewing machine should be selected as it has higher NPV and present value index.