Doughboy Bakery would like to buy a new machine for putting icing and other topp

Question

Doughboy Bakery would like to buy a new machine for putting icing and other toppings on pastries. These are now put on by hand. The machine that the bakery is considering costs $85,000 new. It would last the bakery for ten years but would require a $10,500 overhaul at the end of the seventh year. After ten years, the machine could be sold for $9,000 The bakery estimates that it will cost $19,500 per year to operate the new machine. The present manual method of putting toppings on the pastries costs $39,000 per year. In addition to reducing operating costs, the new machine will allow the bakery to increase its production of pastries by 8,000 packages per year. The bakery realizes a contribution margin of $0.70 per package. The bakery requires a 13% return on all investments in equipment. (Ignore income taxes.) Required:What are the annual net cash inflows that will be provided by the new machine Compute the new machine's net present value. Use the incremental cost approach .

Explanation / Answer

1. Savings in cost = 39,000 - 19,500 = $19,500
Increase in contribution = 8,000 x 0.7 = $5,600
Annual Net cash inflows = 19,500 + 5,600 = $25,100

2. Net present value = Present value of cash inflows - present value of cash outflows
Present value of cash inflows = 25,100 x PVAF(13%, 10years) + 9,000 x PVF(13%, 10years) = (25,100 x 5.426) + (9,000 x 0.295) = $138,850
Present Value of cash outflows = 85,000 + 10,500 x PVF(13%, 7years) = 85,000 + (10,500 x 0.425) = $89,463
Net present value = 138,850 - 89,463 = $49,387

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