The Sweetwater Candy Company would like to buy a new machine that would automati

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 $230,000. 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 $11,500, including installation. After five years, the machine could be sold for $8,000.

      The company estimates that the cost to operate the machine will be $9,500 per year. The present method of dipping chocolates costs $55,000 per year. In addition to reducing costs, the new machine will increase production by 7,000 boxes of chocolates per year. The company realizes a contribution margin of $1.75 per box. A 13% 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.

  

What are the annual net cash inflows that will be provided by the new dipping machine?

Compute the new machine’s net present value.

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 $230,000. 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 $11,500, including installation. After five years, the machine could be sold for $8,000.

      The company estimates that the cost to operate the machine will be $9,500 per year. The present method of dipping chocolates costs $55,000 per year. In addition to reducing costs, the new machine will increase production by 7,000 boxes of chocolates per year. The company realizes a contribution margin of $1.75 per box. A 13% 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.

Explanation / Answer

Reduction in annual operating costs:

Purchase of machine

The Sweetwater Candy Company 1 Net Annual Cash Inflow

Reduction in annual operating costs:

Amt $ Operating costs, present hand method              55,000 Operating costs, new machine                9,500 Annual savings in operating costs              45,500 Increased annual contribution margin              12,250 Total annual net cash inflows              57,750 2 NPV Calculation Now Year 1 Year 2 Year 3 Year 4 Year 5

Purchase of machine

        (230,000) Annual net cash inflows       57,750       57,750       57,750       57,750       57,750 Replacement parts    (11,500) Salvage value of machine         8,000 Total cash flows         (230,000)       57,750       57,750       46,250       57,750       65,750 Discount factor (13%)                        1       0.8850       0.7831       0.6931       0.6133       0.5428 Present value         (230,000)       51,106       45,227       32,054       35,419       35,686 Net present value $       (30,508) Tax rate and depreciation details not provided in the question , so ignored for cash flow caclculation. NPV shown may vary with given answer due to difference in discount factor digits used, here 4 digit factor used for accuracy.

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