Question

Diamond & Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 150 baseballs per hour to sewing 290 per hour. The contribution margin per unit is $0.32 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $21 per hour. The sewing machine will cost $260,000, have an eight-year life, and will operate for 1,800 hours per year. The packing machine will cost $85,000, have an eight-year life, and will operate for 1,400 hours per year. Diamond & Turf seeks a minimum rate of return of 15% on its investments.

Calculate the NPV and PV index for both machines (the packing machine will have a higher PV index). What machine should be purchased? Address both financial and non-financial reasons for your decision. Is there ever a reason to chose an alternative that is not the best financially?

Answer 1

sewing machine (base ball)

cost = $260000

life = 8 years

expected annual cash flow = 290 units per hour * $0.32 contribution margin * 1800 hours per year

= 290*0.32*1800 = $ 167040

automatic packing machine (golf ball)

cost = $ 85000

life = 8 years

expected annual cash flow = $21 savings in labour cost * 1400 hours per year

= 21*1400 = $ 29400

calculation of NPV of sewing machine (base ball) , MARR = 15%

years	annual cash flow	PVF @ 15%	PV of ACF
1	167040	0.861	143821.44
2	167040	0.743	125062.12
3	167040	0.642	108749.67
4	167040	0.555	94564.93
5	167040	0.481	82230.37
6	167040	0.417	71504.67
7	167040	0.362	62177.98
8	167040	0.315	54067.81
			742178.99

NPV = present value of cash inflows - Investment = 742178.99 - 260000 = 482178.99

PV index = NPV / Investment = 482178.99/260000 = 1.8545

calculation of NPV of automatic packing machine (golf ball), MARR = 15%

year	annual cash flow	PVF @ 15 %	PV of ACF
1	29400	0.861	25313.4
2	29400	0.743	22011.65
3	29400	0.642	19140.57
4	29400	0.555	16643.97
5	29400	0.481	14473.02
6	29400	0.417	12585.23
7	29400	0.362	10943.68
8	29400	0.315	9516.24
			130627.76

NPV = present value of cash inflows - Investment = 130627.76 - 85000 = 45627.76

PV index = NPV / Investment = 45627.76/85000 = 0.537

1. sewing machine should be purchased.

2. sewing machine should be purchased as its NPV and PV index are higher than automatic packing machine. higher NPV and PV index will increase the profits and shareholders wealth.

3. as per the given data in the question, there is no requirement of choosing an alternative that is not best financially.