Question

Net Present Value/Uncertain Cash Flows

Tiger Computers, Inc., of Singapore is considering the purchase of an automated etching machine for use in the production of its circuit boards. The machine would cost $800,000. An additional $550,000 would be required for installation costs and for software. Management believes that the automated machine would provide substantial annual reductions in costs, as shown below:

	Annual Reduction in Costs
Labor costs	$140,000
Material costs	$96,000

The new machine would require considerable maintenance work to keep it properly adjusted. The company’s engineers estimate that maintenance costs would increase by $5,000 per month if the machine were purchased. In addition, the machine would require an $81,000 overhaul at the end of the sixth year.

The new etching machine would be usable for 10 years, after which it would be sold for its scrap value of $300,000. It would replace an old etching machine that can be sold now for its scrap value of $61,000. Tiger Computers, Inc., requires a return of at least 16% on investments of this type.

a) Compute the annual net cost savings promised by the new etching machine.

Reduction in labor costs
+ Reduction in material costs
= Total cost reductions
- increased maintenance costs
= Annual net cost savings

b) Using the data from requirement (a) and other data from the problem, compute the new machine’s net present value (Answer: NPV= ($403,502)).

	Year	Cash Flow	16% Factor	PV
Cost of the machine
Installation and software
Salvage of the old machine
Annual cost savings
Overhaul required
Salvage of the new machine
Net present value

c) Based upon NPV, would you recommend that the machine be purchased?

d) Assume that management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of circuit board to another, improved quality of output, and faster delivery as a result of reduced throughput time. What dollar value per year would management have to attach to these intangible benefits in order to make the new etching machine an acceptable investment? (Answer:$83,489)

Answer 1