Question

Carlson Bottling Corporation is considering the purchase of a new bottling machine. The machine would cost $300,000 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 flows of $52,500. 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. (a) What is the net present value of the project? Assume a discount rate of 9%. (b) How much would the reduction in downtime have to be worth in order for the project to be acceptable?

Answer 1

a) initial outlay = -$300,000

net cash flows years 1 - 8 = $52,500

discount rate = 9%

using a financial calculator, NPV = -$9,422, this means that the project should be rejected

b) In order for the project to be accepted, its NPV ≥ 0, therefore, the reduction in downtime should be worth at least $9,422 (at present day dollars).

If we analyze it on a yearly basis, the reduction in downtime should be worth $9,422 / 5.5348 (PV annuity, 9%, 8 periods) = $1,702.32