Net Present Value Method and Present Value Index

Diamond & Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 150 baseballs per hour to sewing 290 per hour. The contribution margin per unit is $0.32 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $21 per hour. The sewing machine will cost $260,000, have an eight-year life, and will operate for 1,800 hours per year. The packing machine will cost $85,000, have an eight-year life, and will operate for 1,400 hours per year. Diamond & Turf seeks a minimum rate of return of 15% on its investments.

Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company

Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $68,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $34,000. The company's minimum desired rate of return for net present value analysis is 15%.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Compute the following:

a. The average rate of return, giving effect to straight-line depreciation on the investment. If required, round your answer to one decimal place. fill in the blank 1%

b. The cash payback period.

2 years3 years4 years5 years6 years7 years8 years2 years

c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value for current grading purpose.

Present value of annual net cash flows	$fill in the blank 3
Amount to be invested	$fill in the blank 4
Net present value

a. Determine the net present value for the two machines. Use the table of present values of an annuity of $1 above. Round to the nearest dollar.

	Sewing Machine	Packing Machine
Present value of annual net cash flows	$fill in the blank 1	$fill in the blank 2
Amount to be invested	$fill in the blank 3	$fill in the blank 4
Net present value	$fill in the blank 5	$fill in the blank 6

b. Determine the present value index for the two machines. Round to two decimal places.

	Sewing Machine	Packing Machine
Present value index	fill in the blank 7	fill in the blank 8

c. If Diamond & Turf has sufficient funds for only one of the machines and qualitative factors are equal between the two machines, in which machine should it invest?

Packing MachineSewing MachinePacking Machine

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