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.


Compute the new machine's net present value. Use the incremental cost approach.
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Explanation / Answer

Item

Year(s)

Amount of Cash Flows

20% Factor

Present Value of Cash Flows

Cost of the machine

Now

$(120,000)

1.000

$(120,000)

Replacement of parts

6

$(9,000)

0.335

(3,015)

Annual net cash inflows

1-12

$32,000

4.439

142,048

Salvage value of the
machine

12

$7,500

0.112

         840

Net present value

$   19,873

Item

Year(s)

Amount of Cash Flows

20% Factor

Present Value of Cash Flows

Cost of the machine

Now

$(120,000)

1.000

$(120,000)

Replacement of parts

6

$(9,000)

0.335

(3,015)

Annual net cash inflows

1-12

$32,000

4.439

142,048

Salvage value of the
machine

12

$7,500

0.112

         840

Net present value

$   19,873

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