1. Johnston Aggregates Ltd. sells 24,000 bags of a certain product for $96 per bag. This product is produced using a machine which was purchased five years ago at a cost of $625,000. It presently has a book value of $375,000 and a salvage value of $47,000. The machine is expected to last another five years after which it will have no salvage value.

Currently the costs per bag are as follows:

Direct materials, 5 kg @ $1.62/kg

Direct labour 4.25 hrs @ $15.80/hr

Variable overhead 4 hrs @ $1.34/hr

Fixed overhead, based on an annual activity level of 100,000 direct labour hours 4hrs @ $1.65/hr

In 2022 the Company expects the following cost escalations:

The selling price will increase by 9.75%

Direct labour rates will increase by 8.37%

Sales are expected to increase to 27,800 bags per year and remain at that level.

Management is presently considering the replacement of their old machine with a new one which would cost $825,000 and ready to be used on January 1, 2022. The new machine is expected to last five years with a salvage value of $42,000. By using the new machine, it is expected to cut the variable direct labour hours to 3.5 hours per bag. However, additional annual labour costs of $56,000 will be required. The Company has a minimum desired rate of return on investments of 10%.

Ignoring taxes and depreciation expenses calculate the net present value of the proposed investment. Discuss your results.

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