Problem:
Doughboy Bakery would like to buy a new machine for putting icing and other toppings on pastries. These are now put on by hand. The machine that the bakery is considering costs $81,000 new. It would last the bakery for nine years but would require a $6,000 overhaul at the end of the fifth year. After nine years, the machine could be sold for $4,000.
The bakery estimates that it will cost $11,000 per year to operate the new machine. The present manual method of putting toppings on the pastries costs $31,000 per year. In addition to reducing operating costs, the new machine will allow the bakery to increase its production of pastries by 2,000 packages per year. The bakery realizes a contribution margin of $0.40 per package. The bakery requires a 5% return on all investments in equipment. (Ignore income taxes.)
Required to do:
Q1. What are the annual net cash inflows that will be provided by the new machine?
Q2. Compute the new machine's net present value. Use the incremental cost approach.