Question

In: Accounting

TopCap Co. is evaluating the purchase of another sewing machine that will be used to manufacture...

TopCap Co. is evaluating the purchase of another sewing machine that will be used to manufacture sport caps. The invoice price of the machine is $120,500. In addition, delivery and installation costs will total $4,500. The machine has the capacity to produce 12,000 dozen caps per year. Sales are forecast to increase gradually, and production volumes for each of the five years of the machine's life are expected to be as follows: Use Table 6-4. (Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals.)

2019 3,600 dozen
2020 5,600 dozen
2021 8,500 dozen
2022 11,300 dozen
2023 12,000 dozen


The caps have a contribution margin of $9.00 per dozen. Fixed costs associated with the additional production (other than depreciation expense) will be negligible. Salvage value and the investment in working capital should be ignored. TopCap Co.'s cost of capital for this capacity expansion has been set at 12%.   

Required:

  1. Calculate the net present value of the proposed investment in the new sewing machine.
  2. Calculate the present value ratio of the investment.
  3. What is the internal rate of return of this investment relative to the cost of capital?
  4. Calculate the payback period of the investment.

Solutions

Expert Solution

1

Net present value=Present value of cash inflow-Initial cash outflow

Initial cash outflow=$120,500+4,500= $125,000

Depriciation expense= 125,000/5= $25,000

Present value of cash inflow (Net of depreciation) is calculated as below

Present value of cash inflows=28,930+40,179+54,453+64,630+61,279

=$159,351

NPV=159,351-125,000

NPV=$ 34,351

2

Present value ratio=Preset valueof cash inflows/Initial cash outflow

=$159,351/125,000

Present value ratio=1.27

3

Internal rate of return is the rate of return at which NPV=0, so this could be calculated using excel or through hit and trial method

IRR=20%

4

Payback period= THe period in which we will recover are initial cash outflow

So to calculate. this we will deduct each year cash inflow from initial cash outflow until cash outflow becomes zero.

We see in year 4 the initial cash outflow is becoming poitive to calculate exact year of payback period use below formula

Payback period= 3+(40,700/76,700)

Payback period=3.5 years

40,700 is remaining cash balance to be utilised which will be utilsed by 4th year 76,700 cash balance so we divide cash balance to be utilised out of the total cash inflow for year 4 it gives the time period in years.


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