El Cheapo Bakery would like to buy a new machine for putting icing and other top

Question

El Cheapo Bakery would like to buy a new machine for putting icing and other toppigs on pastries. These are now put on by hand. The machine that the bakery is considering costs $90,000 new. It would last the bakery for eight years but would require a $7,500 overhaul at the end of the fifth year. After eight years, the machine could be sold for $6,000.

The bakery estimates that it will cost $14,000 per year to operate the new machine. The present manual method of putting toppings on the pastries ost $35,000 per year. In addition to reducing operating costs, the new machine will allow the bakery to increase its production of pastries by 5,000 packages per year. The bakery realizes a contribution margin of $0.60 per package. The bakery requires a 16% return on all investments in equipment.

A. Determine the annual net cash inflows that will be provided by the new machine. SHOW YOUR WORK and CALCULATIONS.

B. Compute the new machine's net present value. Use the incremental cost approach, and round all dollar amounts to the nearest whole dolar. SHOW YOUR WORK and CALCULATIONS.

Explanation / Answer

A) Savings in operating costs (35000-14000) = $21000 Increase in contribution margin ($0.6*5000) = $3000 Net cash inflows that will be provided by the new machine = $21000+$3000 = $24000 B) Net present value = present value of cash outflow - present value cash inflow Present value of cash outflow = $90000 + $7500*PVIF @ 16% 5 years = $90000+3571 = $93571 Present value cash inflow = $24000*PVIFA @16% 8 years = $24000*4.3436 = $104246 NPV = $104246-$93571 = $10675 Note : The PV of overhaul cost also can be reduced from PV total cash inflow instead of adding to the PV of cash oufflow

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