Problem 10-1 Performing a Basic NPV Analysis (LO2 - CC8) The Sweetwater Candy Co

Question

Problem 10-1 Performing a Basic NPV Analysis (LO2 - CC8) 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 $145,000. 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 $9,800, including installation. After 12 years, the machine could be sold for about $7,250. The company estimates that the cost to operate the machine will be only $11,000 per year. The present method of dipping chocolates costs $46,000 per year. In addition to reducing costs, the new machine will increase production by 4,000 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. Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables. Required: 1. What are the net annual cash inflows that will be provided by the new dipping machine? Net annual cash inflows 2. Compute the new machine's net present value using the incremental cost approach. (Round discount factor(s) to 3 decimal places.) Net present value

Explanation / Answer

Req 1 Annual cash inflows from New machine: Additional contribution earned from new machine (4000 units @ 1.50) 6000 Add: savings in cost Savings in manual dipping cost 46000 Less: Annual operating cost 11000 Net Ssavings in cost 35000 Annual cash inflows from New machine: 41000 Net Annual cash inflows: 41000 Req 2: Net present Value: Present value of cash inflows: Present value of annual cash inflows($41000* Present Annuity factor i.e. 4.4392) 182007.2 Present value of salvage rea;ised at end of 12 years ($7250* PVf i.e. 0.1122) 813.45 Total present value of cash inflows 182821 Present value of cash outflows: Initial Investment 145000 Present value of replacement cost ($ 9800*PVF of Year-3 i.e.0.3349) 3282.02 Total Present value of cash outflows 148282 NET PRESENT VALUE 34539

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