Question

The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation currently is done largely by hand. The machine the company is considering costs $180,000. 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 $9,900, including installation. After five years, the machine could be sold for $5,000. The company estimates that the cost to operate the machine will be $7,900 per year. The present method of dipping chocolates costs $39,000 per year. In addition to reducing costs, the new machine will increase production by 6,000 boxes of chocolates per year. The company realizes a contribution margin of $1.30 per box. A 15% 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.

Answer 1

1. Annual net cash inflows that will be provided by the new dipping machine is:

Cost to operate the machine will be $7,900 per year

Saving of cost for present method of dipping chocolates costs $39,000 per year.

Increase in production of chocolate box 6,000*1.3 = 7,800

So net cash inflow each year will be (39,000+7,800-7,900) = 38,900

2. new machine’s net present value is:

Purchase Machine	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Cost of Machine	($180,000)						($180,000)
Overhaul cost				-9,900			($9,900)
Sale of old equipment							$0
Salvage Value						5,000	$5,000
Operating Cost		-7,900	-7,900	-7,900	-7,900	-7,900	($39,500)
Saving Cost		39,000	39,000	39,000	39,000	39,000	$195,000
Increase in production		7,800	7,800	7,800	7,800	7,800	$39,000
Net Cash Flow	($180,000)	$38,900	$38,900	$29,000	$38,900	$43,900	$9,600
Discount rate 15% , Life 5 years
Present Value factor	1	0.870	0.756	0.658	0.572	0.497
Present Value of Net Cash flow	-180,000	33,826	29,414	19,068	22,241	21,826	($53,625)
Net Present value	-180,000	33,826	29,414	19,068	22,241	21,826	($53,625)