Question

“I’m not sure we should lay out $325,000 for that automated welding machine,” said Jim Alder, president of the Superior Equipment Company. “That’s a lot of money, and it would cost us $89,000 for software and installation, and another $54,000 per year just to maintain the thing. In addition, the manufacturer admits it would cost $52,000 more at the end of three years to replace worn-out parts.” “I admit it’s a lot of money,” said Franci Rogers, the controller. “But you know the turnover problem we’ve had with the welding crew. This machine would replace six welders at a cost savings of $119,000 per year. And we would save another $8,000 per year in reduced material waste. When you figure that the automated welder would last for six years, I’m sure the return would be greater than our 16% required rate of return.” “I’m still not convinced,” countered Mr. Alder. “We can only get $19,500 scrap value out of our old welding equipment if we sell it now, and in six years the new machine will only be worth $35,000 for parts. But have your people work up the figures and we’ll talk about them at the executive committee meeting tomorrow.” Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Compute the annual net cost savings promised by the automated welding machine. 2a. Using the data from (1) above and other data from the problem, compute the automated welding machine’s net present value. 2b. Would you recommend purchasing the automated welding machine? 3. Assume that management can identify several intangible benefits associated with the automated welding machine, including greater flexibility in shifting from one type of product to another, improved quality of output, and faster delivery as a result of reduced throughput time. What minimum dollar value per year would management have to attach to these intangible benefits in order to make the new welding machine an acceptable investment?

Answer 1

Reduction in material cost	8,000
Reduction in labor cost	119,000
Total saving	127,000
Less: increase in maintenance cost per year	54,000
Annual net saving	73,000

At end of Year	0	1	2	3	4	5	6
Cost of the machine	(325,000)
Software and installation cost	(89,000)
Salvage of the old equipment	19,500
Replacement of parts				(52,000)
Annual net saving		73,000	73,000	73,000	73,000	73,000	73,000
Salvage of the new machine							35,000
Total cash inflow (outflow)	(394,500)	73,000	73,000	21,000	73,000	73,000	108,000
Multiplied by: Discount factor @ 16%	1	0.862069	0.7431629	0.64065767	0.5522911	0.476113	0.41044225
Present value	(394,500.00)	62,931.03	54,250.89	13,453.81	40,317.25	34,756.25	44,327.76
Net present value	(144,463.00)
Automated welding machine should not be purchased because net present value of automated welding machine is negative.

Year	Discount factor @ 16%
1	0.862069
2	0.743163
3	0.640658
4	0.552291
5	0.476113
6	0.410442
Total	3.684736
Minimum dollar value per year for intangible benefits (144463/3.684736)	$         39,206
If management believes that value of intangible benefits at least $39206 per year then automated welding machine should be purchased.