Blue Shipping is considering the purchase of two different pieces of equipment, as described below:
Machine A - A machine has come onto the market that would allow Blue Shipping to process and sell an item that was previously a waste product. The following information is available on the machine:
a. The machine would cost $350,000 and would have a 10 percent salvage value at the end of its 8-year useful life. The company uses straight-line depreciation and considers salvage value in computing depreciation deductions.
b. The new product from the machine would generate revenues of $500,000 per year. Variable manufacturing expenses would be 60 percent of sales.
c. Fixed expenses associated with the new product would be (per year): advertising, $26,000; salaries, $90,000; and insurance $4,000.
Machine B - Another machine has come onto the market that would allow Blue Shipping to dispose of some antiquated, hand-operated wrapping equipment and replace it with a largely automatic wrapping process. The following information is available:
a. The new wrapping machine would cost $250,000 and would have no salvage value at the end of its 5-year useful life.
b. The old hand-operated wrapping equipment could be sold now for $10,000.
c. The new machine would provide substantial annual savings in cash operating costs. It would require an operator at an annual salary of $12,000, and it would require $4,500 in annual maintenance costs. The old hand-operated equipment cost $105,000 per year to operate.
Blue Shipping's cost of capital for all capital investments is 10%.
REQUIRED (ignore income taxes):
1. For machine A:
a. Prepare an income statement showing the contribution margin and the expected net income each year from the new product.
b. Compute machine A's payback period. (Keep in mind that payback period and net present value computations use cashflows in their computations, not net income.)
c. Compute machine A's net present value.
2. For machine B:
a. Compute the net annual cost savings (cashflows) that would be realized from machine B.
b. Compute machine B's payback period.
c. Compute machine B's net present value.
3. Blue Shipping can only afford to invest in one of these machines. Based on the results of your analysis and other elements of risk, which machine, if either, should the company buy? Explain why in detail?