The Sweetwater Candy Company would like to buy a new machine that would automati
ID: 2595216 • Letter: T
Question
The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation currently is done largely by hand. The machine the company is considering costs $120,000. The manufacturer estimates that the machine would be usable for five years but would require the replacement of several key parts at the end of the third year. These parts would cost $9,000, including installation. After five 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.
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What are the annual net cash inflows that will be provided by the new dipping machine?
2. Compute the new machine’s net present value.
Explanation / Answer
Answer:
A)
Calculation of the annual net cash inflows that w ill be provided by the new dipping machine
Reduction in annual operating costs:
Operating costs, present hand method
$30,000
Operating costs, new machine
7,000
Annual savings in operating costs
23,000
Increased annual contribution margin:
6,000 boxes × $1.50 per box
9,000
Total annual net cash inflows
$32,000
The annual net cash inflows would be:
$32,000
__________________________
2
Calculation of the the new machine's net present value
Item
Year(s)
Amount of Cash Flows
20% Factor
Present Value of Cash Flows
Cost of the machine
Now
($120,000)
1
($120,000)
Replacement of parts
6
($9,000)
0.335
-3,015
Annual net cash inflows (above)
12-Jan
$32,000
4.439
142,048
Salvage value of the
12
$7,500
0.112
840
machine
Net present value
$ 19,873
NPV of the Machine is $19,873
Reduction in annual operating costs:
Operating costs, present hand method
$30,000
Operating costs, new machine
7,000
Annual savings in operating costs
23,000
Increased annual contribution margin:
6,000 boxes × $1.50 per box
9,000
Total annual net cash inflows
$32,000
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