Question 1 You are the nancial executive of Coffee Manufacturing Company (CMC), the manufacturing division has been evaluating various new coffee grinding machines to replace its fully depreciated old grinder. The new coffee grinder is to be used in production in an effort to improve the production process and reduce maintenance costs. To date they have spent $126,000 evaluating ve different grinding machines and have now settled on a German Grinding Machine GGM as it will improve efciency of the production process and reduce raw material requirements. In addition GGM produces a byproduct that can be sold instead of rubbish. The new GGM machine will cost $150,000. CMC is considering using a bank loan to nance the new machine purchase at an interest rate of 8.75% with payments of $31,500 per year. The old existing machine has been fully depreciated for tax purposes but can be sold today for $25,000. The GGM machine can be depreciated over a tax estimated 12 year life straight- line. Due to the complexity of the GGM machine it will last 5 years before requiring replacement. The old machine was very compact and occupied a small amount of CMC's factory space. CMC has been renting its spare factory space to a third party for $35,000 per year. Due to the byproducts generated by the new machine and the bigger size of GGM, CMC will have to cancel the existing lease with the external tenant and take over the space. This will require a compensation payment to the tenant of $21,000 which is an allowable tax- deduction when paid. The GGM machine will have a limited salvage value at the end of the ve year life, CMC estimates the salvage value of $67,000 at the end of 5 years. The GGM machine will have to be serviced by GGM specialists. The service contract will cost $54,000 annually, which is less than the current $74,000 spent on maintenance. The main reason on buying the GGM machine is it is more efcient. CMC will be able to increase sales to $130,000 per year and the associated reduction in cash expenses, including raw materials savings are expected to be $39,000 per year. The by-product will be sold for $9,000 a year and is in addition to the $130,000. The more efcient output of the machine will enable CMC to reduce its holdings of raw materials by $66,000 at the beginning of the rst year. CMC conducts all its capital evaluations in constant dollars and has a management deprecation policy that requires depreciating all assets over a ten year life. The management of CMC is concerned about the consulting costs of $126,000 already paid to consultants and have suggested that this cost should be spread over the 5 years of the projects life. CMC's tax rate is 30% and they use a real required rate of 14%. They expect ination over the ve year period to be 3%pa. a) What are the cash ows at the start? b) What are the cash ows over the life? c) What are the cash ows at the end? d) What is the NPV? e) What is your advice to CMC
