Problem 3

Basic Net Present Value Analysis

Sweetstuff Bakery would like to buy a special machine for icing and applying other toppings to pastries. These are now applied 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 icing and other toppings on the pastries costs $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.

Required:

(Ignore income taxes.)

1. What are the net annual cash inflows that will be provided by the new machine?
2. Compute the new machine's net present value. Use the incremental cost approach, and round all dollar amounts to the nearest whole dollar.