Question

“I’m not sure we should lay out $375,000 for that automated welding machine,” said Jim Alder, president of the Superior Equipment Company. “That’s a lot of money, and it would cost us $99,000 for software and installation, and another $5,500 every month just to maintain the thing. In addition, the manufacturer admits that it would cost $62,000 more at the end of three years to replace worn-out parts.”

     

“I admit it’s a lot of money,” said Franci Rogers, the controller. “But you know the turnover problem we’ve had with the welding crew. This machine would replace six welders at a cost savings of $129,000 per year. And we would save another $9,000 per year in reduced material waste. When you figure that the automated welder would last for six years, I’m sure the return would be greater than our 14% required rate of return.”

“I’m still not convinced,” countered Mr. Alder. “We can only get $24,500 scrap value out of our old welding equipment if we sell it now, and in six years the new machine will only be worth $45,000 for parts. But have your people work up the figures and we’ll talk about them at the executive committee meeting tomorrow.”

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

  

Required:
1.	Compute the annual net cost savings promised by the automated welding machine.

     

2a.	Using the data from (1) above and other data from the problem, compute the automated welding machine’s net present value. (Any cash outflows should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s).)

      

2b.	Would you recommend purchasing the automated welding machine?
	Yes No
3.	Assume that management can identify several intangible benefits associated with the automated welding machine, including greater flexibility in shifting from one type of product to another, improved quality of output, and faster delivery as a result of reduced throughput time. What minimum dollar value per year would management have to attach to these intangible benefits in order to make the new welding machine an acceptable investment? (Use the appropriate table to determine the discount factor(s).)

      

Required 1. Compute the annual net cost savings promised by the automated welding machine. Reduction in labor costs 129,000 Reduction in material waste 9,000 138,000 Total Less increased maintenance costs 64,800 S 73200 Annual net cost savings 2a. Using the data from (1) above and other data from the problem, compute the automated welding machine's net present value. (Any cash outflows should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s).) Now 1 2 3 4 5 (375,000) Cost of machine (99,000) Software and installation Salvage value of old equipment 24,500 132.500 132.500 132,500 132.500 132.500 132.500 Annual net cost savings Replacement of parts (62,000) 45.000 Salvage value of new machine (449,500) 132,500 132,500 70,500 132.500 132,500 177,500 Total cash flows Discount factor (14%) 0.670 0.460 47,235 78.175 0 116,600 102,025 68,900 Present value 81,650 494,585 Net present value 2b. Would you recommend purchasing the automated welding machine? Yes No

Answer 1

1	Computation of annual net cost savings by installing automated welding machine
		$
	Welder's cost savings	1,29,000
	Reduction in material waste	9,000
		1,38,000
	Less: Maintenance cost per annuam ($ 5,500 x 12)	(66,000)
	Annual net cost savings	72,000
2	Computation of Net Present value (NPV)
Year		Cash Flow $	PV factor at 14%	Discounted Cash Flow $
0	Inetial cost ($ 375,000 + $ 99,000)	-474000	1	(4,74,000.00)
0	Scrap value of old Machine	24500	1	24,500.00
1	Annual cost savings	72,000	0.8772	63,157.89
2	Annual cost savings	72,000	0.7695	55,401.66
3	Annual cost savings	72,000	0.6750	48,597.95
3	Replacement cost of worn-out parts	(62,000)	0.6750	(41,848.23)
4	Annual cost savings	72,000	0.5921	42,629.78
5	Annual cost savings	72,000	0.5194	37,394.54
6	Annual cost savings	72,000	0.4556	32,802.23
6	Salvage value of Machine	45,000	0.4556	20,501.39
	NPV			(1,90,862.78)
	Based on NPV , compnay should not purchase the new machine, since it's NPV is negative.