Question

Starliper Industries has developed a project to produce a new product: Widgets. To develop the widgets, Starliper Industries needs to purchase a new machine that will help develop the widgets. Starliper Industries is deciding between two different machines, “New Tech” and “Standard Classic” that have the capabilities necessary to develop the widgets. Your job will be to compare the two different machines using net present value. The company has produced the following information regarding the widgets and the two machines: • The cost to purchase “New Tech” will be $421,000 and will have a useful life of 6 years; “New Tech” will have a salvage value of $26,000 at the end of 6 years. The cost to purchase “Standard Classic” will be $235,000 and will also have a useful life of 6 years; “Standard Classic” will have a salvage value of $5,000 at the end of 6 years. • Total Contribution Margin from the sale of Widgets will be different for each machine because the “Standard Classic” machine requires more variable manufacturing overhead costs. The expected contribution margin if the “New Tech” machine is chosen is the following: Year Total Contribution Margin 1 $180,000 2 $300,000 3 $360,000 4-6 $440,000 The contribution margin if the “Standard Classic” is chosen is expected to be the following: Year Total Contribution Margin 1 $175,000 2 $280,000 3 $355,000 4-6 $438,000 • Working Capital of $53,000 will be required at the beginning of the production of Widgets for the “New Tech” machine, and working capital of $95,000 will be required at the beginning of the production of Widgets for the “Standard Classic” machine. For both machines the working capital will be released at the end of the project (i.e., end of year 6). • The yearly cost of machine maintenance will be $50,000 for the “New Tech” and will be $72,000 for the “Standard Classic” machine. • Other fixed costs for salaries, property taxes, and insurance, which will be the same regardless of the machine chosen, will be the following: Year Total Other Fixed Costs 1-2 $180,000 3 $150,000 4-6 $120,000 • The “Standard Classic” machine will require a major overhaul that will cost $100,000 at the end of year 3 of the project. This will not apply to the “New Tech” machine. • The Required Rate of Return for Starliper Industries is 9%. • Use the “Total-Cost Approach” as described in section “Expanding the Net Present Value Method” on page 646 of the textbook

HOW TO CALCULATE THE NET PRESENT VALUE AND PROJECT PROFABILITY USING EXCEL FORMULA

Answer 1

New Tech Machine
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Total contribution margin		$                        1,80,000	$                              3,00,000	$                                   3,60,000	$                              4,40,000	$                              4,40,000	$                              4,40,000
Salvage value							$                                 26,000
Working capital		$                         -53,000					$                                 53,000
Less:
Total other fixed costs		$                      -1,80,000	$                             -1,80,000	$                                  -1,50,000	$                             -1,20,000	$                             -1,20,000	$                             -1,20,000
Yearly cost of maintainence		$                         -50,000	$                                -50,000	$                                     -50,000	$                                -50,000	$                                -50,000	$                                -50,000
Net cashflows	$                     -4,21,000	$                      -1,03,000	$                                 70,000	$                                   1,60,000	$                              2,70,000	$                              2,70,000	$                              3,49,000
PV factor @ 9%	1.00	0.92	0.84	0.77	0.71	0.65	0.60
PV of net cashflows	$                     -4,21,000	$                         -94,495	$                                 58,918	$                                   1,23,549	$                              1,91,275	$                              1,75,481	$                              2,08,097
NPV	$                       2,41,825
Standard Classic
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Total contribution margin		$                        1,75,000	$                              2,80,000	$                                   3,55,000	$                              4,38,000	$                              4,38,000	$                              4,38,000
Salvage value							$                                    5,000
Working capital		$                         -95,000					$                                 95,000
Less:
Total other fixed costs		$                      -1,80,000	$                             -1,80,000	$                                  -1,50,000	$                             -1,20,000	$                             -1,20,000	$                             -1,20,000
Yearly cost of maintainence		$                         -72,000	$                                -72,000	$                                     -72,000	$                                -72,000	$                                -72,000	$                                -72,000
Overhaul				$                                  -1,00,000
Net cashflows	$                     -2,35,000	$                      -1,72,000	$                                 28,000	$                                      33,000	$                              2,46,000	$                              2,46,000	$                              3,46,000
PV factor @ 9%	1.00	0.92	0.84	0.77	0.71	0.65	0.60
PV of net cashflows	$                     -2,35,000	$                      -1,57,798	$                                 23,567	$                                      25,482	$                              1,74,273	$                              1,59,883	$                              2,06,308
NPV	$                       1,96,715

New tech machine should be chosen as it has greater NPV

Please Like the solution if satisfied with the answer and if any query please mention it in comments...thanks