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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Net present value method and present value index

 Diamond & Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 150 baseballs per hour to sewing 290 per hour. The contribution margin per unit is $0.32 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $21 per hour. The sewing machine will cost $260,000, will have an eight-year life, and will operate for 1,800 hours per year. The packing machine will cost $85,000, will have an eight-year life, and will operate for 1,400 hours per year. Diamond &Turf seeks a minimum rate of return of 15% on its investments.

  1. a. Determine the net present value for the two machines. Use the present value of an annuity of $1 table in the chapter (Exhibit 5). Round to the nearest dollar.
  2. b. Determine the present value index for the two machines. Round to two decimal places.
  3. c. If Diamond fit Turf has sufficient funds for only one of the machines and qualitative factors are equal between the two machines, in which machine should it invest? Explain.

a.

To determine

Cash flow:

Cash flow is the monetary consideration (return or income) received by the business for its long-term capital investment.

Net present value method:

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is determined by the business, based on the net income from the investment, and it is also called as the discounted cash flow method.

To determine: The net present value of both the machines.

Explanation

Annual net cash flow of sewing machine:

Annualnetcashflow}={1,800hours×(290baseballs-150baseballs)}×$0.32perball={1,800hours×140baseballs}×$0

b.

To determine

To calculate: The present value index of both the machine

(c)

To determine

To explain: If D & T Corporation has sufficient funds for only one machine, then in which machine it should invest.

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