A machine costing $25,000 to buy and $3,000 per year to operate, will save mainl

Question

A machine costing $25,000 to buy and $3,000 per year to operate, will save mainly labor expenses in packaging over six years. The anticipated salvage value of the labor expenses in packaging over six years. The anticipated salvage value of the machine at the end of six years is $5000.

a) if 10% return on investments (rate of return) is desired, what is the minimum required annual saveings in labor from this machine?
b) If the service life is just five years, instead of six years, what is the minimum required annual savings in lavore for the firm to realize a 10% return on investment?
c)if the annual operating cost increases 10% say 3000 to 3300 what will hapen to answer a?

Explanation / Answer

a) First we have to calculate the present value of the salvage amount: Step1: Go to excel and "click" insert to insert the function. Step2: Select the "PV" function as we are finding the present value in this case. Step3: Enter the values as Rate = 10%; Nper = 6; PMT = 0; FV = -5000 Step4: Click "OK" to get the desired value. The value comes to "$2,822.37" Now, the present value is $25,000 + $2,822 = $27,822 Calculating the annual cash inflows using excel sheet: Step1: Go to excel and click "insert" to insert the function. Step2: Select the "PMT" function as we are finding the annaul cash inflows Step3: Enter the values as Rate = 10%; Nper = 6; PV = -27822; FV = 0 Step4: Click "OK" to get the desired value. The value comes to " $6,388" Therefore, the annual cash inflows are $6,388 To calculate the annual savings, we deduct the annual operating costs from annual cash inflows Annual savings = $6,388 - $3,000 = $3,388 b) If the service life is just 5yrs, then the annual savings will be calculated as: First we have to calculate the present value of the salvage amount: Step1: Go to excel and "click" insert to insert the function. Step2: Select the "PV" function as we are finding the present value in this case. Step3: Enter the values as Rate = 10%; Nper = 5; PMT = 0; FV = -5000 Step4: Click "OK" to get the desired value. The value comes to "$3,104.61" Now, the present value is $25,000 + $3,104= $28,104 Calculating the annual cash inflows using excel sheet: Step1: Go to excel and click "insert" to insert the function. Step2: Select the "PMT" function as we are finding the annaul cash inflows Step3: Enter the values as Rate = 10%; Nper = 5; PV = -28104; FV = 0 Step4: Click "OK" to get the desired value. The value comes to " $7,413" Therefore, the annual cash inflows are $7,413 To calculate the annual savings, we deduct the annual operating costs from annual cash inflows Annual savings = $7,413 - $3,000 = $4,413 c) c) If the operating costs increases to $3,300 then the annual cash flows will change as: Annual savings = $6,388 - $3,300 = $3,088 Therefore, the annual savings changes to $3,088

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