Stirling Windows Inc. of Hong Kong is considering purchasing an automated cutting machine for use in the production of its stained-glass windows. The machine would cost $675,000. (All currency amounts are in Hong Kong dollars.) An additional $487,500 would be required for installation costs and for software. Management believes that the automated machine would provide substantial annual reductions in costs, as shown below:
Annual Reduction
in Costs
Labour costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . $180,000
Material costs . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 72,000
The new machine would require considerable maintenance work to keep it in proper adjustment. The company’s engineers estimate that maintenance costs would increase by $3,200 per month if the machine were purchased. In addition, the machine would require a $67,500 overhaul at the end of the fifth year.
The new cutting machine would be usable for eight years, after which it would be sold for its scrap value of $157,500. It would replace an old cutting machine that can be sold now for its scrap value of $52,500. Stirling Windows requires a return of at least 16% on investments of this type.
Required:
Ignore income taxes.
1. Compute the net annual cost savings promised by the new cutting machine.
2. Using the data from (1) above and other data from the problem, compute the new machine’s net present value. Would you recommend that the machine be purchased? Explain.
3. Assume that management can identify several intangible benefits associated with the new machine, including greater flexibility in shifting from one type of stained-glass window to another, improved quality of output, and faster delivery as a result of reduced throughput time. What dollar value per year would management have to attach to these intangible benefits in order to make the new cutting machine an acceptable investment?