Problem 10-1 Performing a Basic NPV Analysis (LO2 - CC8) Problem 10-1 Performing

ID: 2555523 • Letter: P

Question

Problem 10-1 Performing a Basic NPV Analysis (LO2 - CC8)

Problem 10-1 Performing a Basic NPV Analysis (LO2 - CC8) 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 $120,000. The manufacturer estimates that the machine would be usable for 12 years, but would require the replacement of several key parts at the end of the sixth year. These parts would cost $7,800, including installation. After 12 years, the machine could be sold for about $6,000. The company estimates that the cost to operate the machine will be only $9,000 per year. The present method of dipping chocolates costs $38,000 per year. In addition to reducing costs, the new machine will increase production by 2,000 boxes of chocolates per year. The company realizes a contribution margin of $1.00 per box. A 20% rate of return is required on all investments. Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables. Required: 1. What are the net annual cash inflows that will be provided by the new dipping machine? Net annual cash inflows 2. Compute the new machine's net present value using the incremental cost approach. (Round discount factor(s) to 3 decimal places.) Net present value

Explanation / Answer

Calculation of net annual cashflows

Particulars

Amount

Savings in operation cost
(38,000-9,000)

$29,000

Increase in contribution margin
(2,000*$1)

$2,000

Total annual cashflows

$31,000

Net present valu = Present value of cash inflows-Present value of cashoutflows

Present value of cash inflows (A)

Annual cash flows

$31,000

Annuity factor @10% for 12 years

4.439

Present value of annual cashflows (31,000*4.439)

$137,609

Add: Salvage value present value
(6,000*0.112)

$672

Total p.v of cashinflows

$138,281

Present value of cash outflows (B)

Machine cost value

$120,000

Add: Present value of repair cost
(7,800*0.335)

$2,613

Total P.V of cashooutflows

$122,613

Ans

Net present value = 138,281-122,613

$15,668