Question

Bernadette Inc. makes bacterial cultures for biology research experiments. She makes each batch by hand which takes a long time. She is thinking of buying a piece of equipment for $80,000 to automate her production and increase her sales. If she buys the machine, she will be able to increase her annual sales by $100,000 per year. The variable product costs associated with these extra sales will amount to $60,000 per year. The machine will require occasional maintenance which will cost $5,000 per year. At the end of the useful life of the equipment (in 10 years’ time), Bernadette will be able to sell the machine for $20,000.

Bernadette Inc. uses an interest rate of 4% in capital budgeting decision making.

Required:

1. What is the net present value of buying the equipment?
2. Should Bernadette buy the equipment? Why or why not?

Answer 1

net present value of buying the equipment	217,392.64
Yes since NPV is positive
Statement showing Cash flows
Particulars	Time	PVf 4%	Amount	PV
Cash Outflows	-	1.00	(80,000.00)	(80,000.00)
PV of Cash outflows = PVCO				(80,000.00)
Cash inflows	1.00	0.9615	35,000.00	33,653.85
Cash inflows	2.00	0.9246	35,000.00	32,359.47
Cash inflows	3.00	0.8890	35,000.00	31,114.87
Cash inflows	4.00	0.8548	35,000.00	29,918.15
Cash inflows	5.00	0.8219	35,000.00	28,767.45
Cash inflows	6.00	0.7903	35,000.00	27,661.01
Cash inflows	7.00	0.7599	35,000.00	26,597.12
Cash inflows	8.00	0.7307	35,000.00	25,574.16
Cash inflows	9.00	0.7026	35,000.00	24,590.54
Cash inflows = 35,000 + 20,000	10.00	0.6756	55,000.00	37,156.03
PV of Cash Inflows =PVCI				297,392.64
NPV= PVCI - PVCO				217,392.64
Sales	100,000.00
Less variable product costs	(60,000.00)
Less occasional maintenance	(5,000.00)
Income	35,000.00