El Cheapo, Inc., of Baja California is considering the purchase of an automated
ID: 2573567 • Letter: E
Question
El Cheapo, Inc., of Baja California is considering the purchase of an automated etching machine for use in the production of its circuit boards. The machine would cost $900,000. (All currency amounts are in U.S.dollars , if that makes a difference.) An additional $650,000 would be required for installation costs and for software. Management believes that the automated machine would provide substantial annual reductions in costs, as shown below:
The new machine would require considerable maintenance work to keep it properly adjusted. The company’s engineers estimate that maintenance costs would increase by $4,250 per month if the machine were purchased. In addition, the machine would require a $90,000 overhaul at the end of the sixth year.
The new etching machine would be usable for 10 years, after which it woul be sold for its scrap value of $210,000. It would replace an old etching machine that can be sold now for its scrap value of $70,000.El Chepo, Inc., requires a return of at least 18% on investments of this type.
Ignore Income Taxes
A. Compute the annual net cost savings promised by the new etching machine.
B. Using the data from requirement (1) and other data from the problem, compute the new machine’s net present value. (Use the incremental-cost approach.) Would you recommend that the machine be purchased? Explain.
C. Assume that the management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of circuit board to another, improved quality of output, and faster delivery as a result of reduced throughput time. What dollar value per year would management have to attach to these intangible benefits in order to make the new etching machine an acceptable investment?
Annual Reduction In Costs $240,000 $96,000 Labor Costs Material CostsExplanation / Answer
A. Annual net cost savings = $285,000 (As shown below B)
B. Net present value:-
(1). Intial outaly of funds
Cost of machine= $900,000
Add:- Additional costs = $650,000
Add:- Present value of overhaul = $33,336
($90,000*1/(1.18)6)
Less:- sale of old machine = - $ 70,000
Total intial outlay of funds = $1,513,336/-
(2). Present value of cash inflow:-
Annual savings in labour = $240,000
Annual savings in material = $96,000
Total savings = $336,000
Less:- Maintenance costs = $51,000
Net Annual savings. = $285,000
Cumulative present value factor= 4.4939
( 18%, 10 years)
Present value of annual savings = $ 1,280,761.50
Add:- Present value of Scap value = $40,110
($210,000*1/(1.18)10)
Present value of cash inflow = $1,320,871.50
(3).Net present value (2-1) (Loss) = - $192,464.50
C. Dollars required for an year to make the newachine acceptable = Net present value / Cumulative present value figure
= $192,464.50/4.4939 = $ 42,827.94/-
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