Stirling Windows Inc. of Hong Kong is considering purchasing an automated cuttin

Question

Stirling Windows Inc. of Hong Kong is considering purchasing an automated cutting machine for use in the production of its stained-glass windows. The machine would cost $820,000. (All currency amounts are in Hong Kong dollars.) An additional $570,000 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 in proper adjustment. The company’s engineers estimate that maintenance costs would increase by $4,020 per month if the machine were purchased. In addition, the machine would require a $82,000 overhaul at the end of the sixth year.

    The new cutting machine would be usable for eight years, after which it would be sold for its scrap value of $230,000. It would replace an old cutting machine that can be sold now for its scrap value of $71,000. Stirling Windows requires a return of at least 14% on investments of this type. (Ignore income taxes.)

Compute the net annual cost savings promised by the new cutting machine.

       

Using the data from requirement 1 above and other data from the problem, compute the new machine’s net present value. (Use the incremental-cost approach.) (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Do not round intermediate calculations and round your final answer to the nearest dollar amount. Negative amount should be indicated by a minus sign.)

         

Assume that management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of stained-glass window 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 cutting machine an acceptable investment? (Hint: Use Microsoft Excel to calculate the discount factor(s).) (Do not round intermediate calculations and round your final answer to the nearest dollar amount.)

       

Stirling Windows Inc. of Hong Kong is considering purchasing an automated cutting machine for use in the production of its stained-glass windows. The machine would cost $820,000. (All currency amounts are in Hong Kong dollars.) An additional $570,000 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:

Explanation / Answer

1. Compute the net annual cost savings promised by the new cutting machine.

Net Annual Cost Savings = (Labor Cost + Materials Cost) - Maintenance Cost

.........................................= $170,000 + $97,000 - ($4,020 x 12 months)

.........................................= $170,000 + $97,000 - $48,240

.........................................= $218,760

2a. Using the data from requirement 1 above and other data from the problem, compute the new machine’s net present value.

2b.  Would you recommend that the machine be purchased?

No

3.Assume that management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of stained-glass window 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 cutting machine an acceptable investment?

Net Present Value that needs to be offset = ($260,933.57)

Present Value factor for 8 years = 4.63886

Intangible Benefits per year = $260,933.57 / 4.63886

.............................................= $56,249

If management thinks there would be intangible benefits worth $56,249 per year, then they can prefer purchasing the machine.

Particulars Year Amount Present Value Factor @14% Present Value Cost of Machine 0 ($820,000) 1 ($820,000.00) Installation Cost 0 ($570,000) 1 ($570,000.00) Salvage of old machine 0 $71,000 1 $71,000.00 Annual Savings 1st - 8th $218,760 4.63886 $1,014,797.01 Cost of Overheaul 6th ($82,000) 0.45559 ($37,358.38) Salvage value of new machine 8th $230,000 0.35056 $80,628.80 Net Present Value ($260,933)

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