The Sweetwater Candy Company would like to buy a new machine that would automati
ID: 2421492 • Letter: T
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 $220,000. 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 $10,300, including installation. After five years, the machine could be sold for $6,000.
The company estimates that the cost to operate the machine will be $8,300 per year. The present method of dipping chocolates costs $43,000 per year. In addition to reducing costs, the new machine will increase production by 5,000 boxes of chocolates per year. The company realizes a contribution margin of $1.50 per box. A 15% 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.
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.)
Explanation / Answer
Solution:
The annual net cash inflows would be:
Reduction in annual operating costs:
Operating costs, present hand method
$43,000
Less: Operating costs, new machine
8,300
Annual savings in operating costs
$34,700
Increased annual contribution margin: 5,000 boxes × $1.50 per box
7500
Total annual net cash inflows
$42,200
Cost of the machine = $220,000
We know that the Replacement of parts = $10,300. The present value of replacement of parts, PV of RP is
PV of RP = $10,300 (PVIF @ 15%, 3)
PV of RP = $10,300 (1/1.15^3)
PV of RP = $10,300 (0.657)
PV = $6,772.417
We know that annual net cash flow from above is $42,200. Now, we calculate the present value of net cash flow (PV of CF)
PV of CF = CF (PVIFA @ I, n)
PV of CF = CF (PVIFA @ 15%, 5)
PV of CF = $42,200 [(1.15^5-1)/ (0.15*1.15^5)]
PV of CF = $42,200 (1.01136/0.30170)
PV of CF = $42,200 (3.352)
PV of CF = $141,460.9
The salvage value of the machine is $6,000 and we calculate the present value of salvage value (PV of SV) as follows:
PV of SV = $6,000 ((PVIF @ 15%, 5)
PV of SV = $6,000 (1/1.15^5)
PV of SV = $6,000 (0.497)
PV of SV = $2,983.06
Therefore, the net present value (NPV) is
NPV = -Cost of the machine – PV of RP + PV of CF + PV of SV
NPV = -$220,000 - $6,772.417 + $141,460.9 + $2,983.06
NPV = -$82,328
Hence, the Net Present Value (NPV) of new machine is -$82,328.
Operating costs, present hand method
$43,000
Less: Operating costs, new machine
8,300
Annual savings in operating costs
$34,700
Increased annual contribution margin: 5,000 boxes × $1.50 per box
7500
Total annual net cash inflows
$42,200
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