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 $210,000. 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 $11,300, 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 $9,300 per year. The present method of dipping chocolates costs $53,000 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 $1.65 per box. A 19% 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.

Required:

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

2. Compute the new machine’s net present value.

Explanation / Answer

1) Savings in oprating costs per annum = $53000-$9300 = $43700 Increase in contribution margin = $1.65*5000 = $8250 Total annual net cash inflows that will be provided by the new dipping machine = $43700+$8250 = $51950 2) NPV = Present value total cash inflow - Initial investment Present value total cash inflow = $51950*PVIFA @ 19% 5 years + $6000*PVIF @19% 5 years - $11300*PVIF @19% 3 years =$51950*3.0576 + $6000*0.419 - $11300*0.5934 = 158844+2514-6706 = $154652 NPV= $154652-$210000 = (-$55348)

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