Blue Spruce Industries is considering the purchase of new equipment costing $684
ID: 362852 • Letter: B
Question
Blue Spruce Industries is considering the purchase of new equipment costing $684,000 to replace existing equipment that will be sold for $102,600. The new equipment is expected to have a $114,000 salvage value at the end of its 2-year life. During the period of its use, the equipment will allow the company to produce and sell an additional 17,100 units annually at a sales price of $11 per unit. Those units will have a variable cost of $7 per unit. The company will also incur an additional $51,300 in annual fixed costs.
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(a) Calculate the net present value of the proposed equipment purchase. Assume that Blue Spruce uses a 7% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971. Enter negative amount using a negative sign preceding the number e.g. -59,992 or parentheses e.g. (59,992).)
Explanation / Answer
Contribution per unit = Sale price – Cost price = $11 - $ 7 = $4 / unit
Therefore, Additional gross contribution from sale of 17100 units = $ 17100 x 4 = $68400
However company in the process will incur additional cost of $51300
Therefore, Net contribution from sale of 17100 units ( for each of 2 years ) = $68400 - $51300 = $17100
Thus yearwise cash flow position as follows :
Year 0 ( Zero) = Outflow denoted as ‘ – ‘ 684000 – 102600 = - $ 582000
Year 1 = Inflow denoted as ‘+’ $17100
Year 2 = i) Inflow + $17100 from net contribution from sale
Ii Inflow + $ 114,000 salvage value
Thus total inflow = $17100 + $114000 = $131100
Since discount rate is 7% , discount factor , d = 1 + 7/100 = 1.07
Therefore Net Present Value
= Outflow of year 0 + Inflow of year 1/d + Inflow of year 2/d^2
= - $582,000 + $17100 /d + $131100/d^2
= - $582,000 + 17100/1.07 + 131100/(1.07 x 1.07)
= - $582,000 +$ 15981.308 + $ 114507.817
= - $451510.87 ( - $451511 rounded to zero decimal places )
NET PRESENT VALUE = - $ 451511
NET PRESENT VALUE = - $ 451511