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Caine Bottling Corporation is considering the purchase of a new bottling machine. The machine would cost S183,399 and has an estimated useful life of 8 years with zero salvage value. Management estimates that the new bottling machine will provide net annual cash fiows of $30,000. Management also believes that the new bottling machine will save the company money because it is expected to be more reliable than other machines, and thus will reduce downtime. Assume a discount rate of 8%.
Calculate the net present value.
How much would the reduction in downtime have to be worth in order for the project to be acceptable?

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Answer:

  • Net Present value = -$11,001
  • Downtime reduction should be worth $11,001

Explanation:

Net Present value = Present value of cash inflows - Cost of machine

As the annual cash flows are constant, they will be treated as annuities:

Present value of cash flows = 30,000 * Present value interest factor of annuity, 8 years, 8%

= 30,000 * 5.7466

= $172,398

Net present value = 172,398 - 183,399

= -$11,001

Reduction in downtime should be worth at least $11,001 so that it would enable the project to breakeven at least.

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