TopCap Co. is evaluating the purchase of another sewing machine that will be used to manufacture sport caps. The invoice price of the machine is $208,000. In addition, delivery and installation costs will total $10,000. The machine has the capacity to produce 18,000 dozen caps per year. Sales are forecast to increase gradually, and production volumes for each of the five years of the machine’s life are expected to be:
2010 . . . . . . . . . . . . . . . . . . . . . . . 5,400 dozen
2011 . . . . . . . . . . . . . . . . . . . . . . . 8,400 dozen
2012 . . . . . . . . . . . . . . . . . . . . . . . 12,750 dozen
2013 . . . . . . . . . . . . . . . . . . . . . . . 13,950 dozen
2014 . . . . . . . . . . . . . . . . . . . . . . . 18,000 dozen
The caps have a contribution margin of $6.00 per dozen. Fixed costs associated with the additional production (other than depreciation expense) will be negligible. Salvage value and the investment in working capital should be ignored. TopCap Co.’s cost of capital for this capacity expansion has been set at 14%.
Required:
a. Calculate the net present value of the proposed investment in the new sewing machine.
b. Calculate the present value ratio of the investment.
c. What is the internal rate of return of this investment relative to the cost of capital?
d. Calculate the payback period of the investment.