Question

Special People Industries (SPI) is a nonprofit organization which employs only people with physical or mental disabilities. One of the organization's activities is to make cookies for its snack food store. Several years ago, Special People Industries purchased a special cookie-cutting machine. As of December 31, 20x0, this machine will have been used for three years. Management is considering the purchase of a newer, more efficient machine. If purchased, the new machine would be acquired on December 31, 20x0. Management expects to sell 300,000 dozen cookies in each of the next six years. The selling price of the cookies is expected to average $1.15 per dozen.

Special People Industries has two options: continue to operate the old machine, or sell the old machine and purchase the new machine. No trade-in was offered by the seller of the new machine. The following information has been assembled to help management decide which option is more desirable.

	Old Machine			New Machine
Original cost of machine at acquisition	$	80,000		$	120,000
Remaining useful life as of December 31, 20x0		6	years		6	years
Expected annual cash operating expenses:
Variable cost per dozen	$	0.38		$	0.29
Total fixed costs	$	21,000		$	11,000
Estimated cash value of machines:
December 31, 20x0	$	40,000		$	120,000
December 31, 20x6	$	7,000		$	20,000

Assume that all operating revenues and expenses occur at the end of the year.

Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.)

Required:

1-a.	Use the net-present-value method to compute the net-present-value for the old machine and the new machine. The organization's hurdle rate is 16 percent.

        

Answer 1

NPV- Old Machinery:
		Year-0	Year-1	Year-2	Year-3	Year-4	Year5	Year-6
Sales revenue		0	345000	345000	345000	345000	345000	345000
Less: Cost
Vvraiable			114000	114000	114000	114000	114000	114000
Fixed			21000	21000	21000	21000	21000	21000
Net Annual Revnue			210000	210000	210000	210000	210000	210000
Add; Salvage value at end of Year-6								7000
Net Cash inflows			210000	210000	210000	210000	210000	217000
PVF			0.862069	0.743163	0.640658	0.552291	0.476113	0.410442
Present value			181034.5	156064.2	134538.1	115981.1	99983.73	89065.97
NPV		776668
NPV-New machinery
		Year-0	Year-1	Year-2	Year-3	Year-4	Year5	Year-6
Initial Investment		-120,000
Salvage value of Old		40,000
Sales revenue		0	345000	345000	345000	345000	345000	345000
Less: Cost
Vvraiable			87000	87000	87000	87000	87000	87000
Fixed			11000	11000	11000	11000	11000	11000
Net Annual Revnue			247000	247000	247000	247000	247000	247000
Add; Salvage value at end of Year-6								20000
Net Cash inflows		-80000	247000	247000	247000	247000	247000	267000
PVF		1	0.862069	0.743163	0.640658	0.552291	0.476113	0.410442
Present value		-80000	212931	183561.2	158242.4	136415.9	117599.9	109588.1
NPV		838338
Hence, the company shall make replacement.