The Sweetwater Candy Company would like to buy a new machine that would automati

Question

The Sweetwater Candy Company would like to buy a new machine that would automatically "dip" chocolates. The dipping operation is currently done largely by hand. The machine the company is considering costs $120,000. The manufacturer estimates that the machine would be usable for 12 years but would require the replacement of several key parts at the end of the sixth year. These parts would cost $9,000, including installation. After 12 years, the machine could be sold for $7,500.


The company estimates that the cost to operate the machine will be $7,000 per year. The present method of dipping chocolates costs $30,000 per year. In addition to reducing costs, the new machine will increase production by 6,000 boxes of chocolates per year. The company realizes a contribution margin of $1.50 per box. A 20% rate of return is required on all investments. (Ignore income taxes.)


To determine the appropriate discount factor(s) using tables, click here to view Exhibit 12B-1 (0.112)and Exhibit 12B-2 (4.439). Alternatively, if you calculate the discount factor(s) using a formula, round to three (3) decimal places before using the factor in the problem.



6. Requirement 1:

What are the annual net cash inflows that will be provided by the new dipping machine?

Annual net cash inflows $



7. Requirement 2:

Compute the new machine's net present value. Use the incremental cost approach. (Round your answer to the nearest dollar amount.)

Net present value $

Explanation / Answer

First of all, like many of these accounting word problems, there is a lot of added information that you don't really need and it is put in just to confuse you. For instance, except for the 20% rate of return, you don't need the information in the second paragraph. They've already done the calculation for you.....ANNUAL NET CASH INFLOWS = 32,000. Now you just need to calculate the present value of each inflow and outflow of cash for each year, add them together, then subtract the beginning cost of $120,000. The cash inflows for each year are as follows.

For years 1-5 the inflows are 32,000 per year.
For the sixth year, you have to subtract 9,000 for replacement parts; so the inflow is 23,000
For years 7-11 the inflows are 32,000 per year
For year 12, you would add the salvage value of 7,500; so the inflow is 39,500.

Using a business calculator or Excel's NPV function, the net present value of the future cash flows is $139,882.03. Subtract the $120,000 initial cost, and your answer is $19,882.03

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