Purchase of machinery and equipment

Producing Combination Washer-Dryer

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Company is considering adding a combination Washer-Dryer units. Following are the given facts.
• Initial cash outlay is $150,000 with no residual value
• Expected sale price is $2,250 per unit, with labor cost of $595 and material cost of $795.
• Direct fixed cost per month is $20,750.
• Cost of capital is 8%, and the required rate of return is 10%
• Company will incur all operational costs in year 1, though sales are expected to be 55% of break-even.
• Break-even (considering only direct fixed costs) is expected to occur in year 2.
• Variable costs will increase 2% each year, starting in year 3 - 5.
• Expected sales growth is 10%, 15% and 20% for years 3 – 5.

❑ Contribution margin is the amount of money a business has in order to cover its fixed costs and contribute to net profit or
loss after paying for its variable costs. (Carlson, 2020)
▪ It is calculated by subtracting the variable cost per unit by sale price of each unit
Contribution margin = $2,250 – ($595 + $795) = $860

❑ A business’s break-even point is the point at which earned revenues is equal to costs (Egan, 2021)
Break-even point = Fixed cost/month ÷ Contribution margin/unit
BEP = ($20,750 per month ÷ $860/unit) 12 months = 290 units/year
Break-even quantity for Year 1 is 55% of BEP = 290 x 0.55 = 160 units

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Calculations
Timeline Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial Cost $150,000
Sales number 160 290 319 367 440
Sales Revenue $357,750 $652,500 $717,750 $825,750 $990,000
Material Cost $127,200 $230,550 $258,677 $303,552 $371,211
Labor Cost $95,200 $172,550 $193,601 $227,187 $277,824

Total Variable Cost $222,400 $403,100 $452,278 $530,739 $649,035

Total Fixed Cost $150,000 $249,000 $249,000 $249,000 $249,000 $249,000

Contribution Margin $135,350 $249,400 $265,472 $295,011 $340,965

Total Cash IN or (OUT) -$150,000 -$113,650 $400 $16,472 $46,011 $91,965
Contribution Margin Ratio
PV Factor (Rate of Return)=10% 1.00 0.91 0.83 0.75 0.68 0.62

NPV -$150,000 -$103,422 $332 $12,354 $31,287 $57,018 -$152,430

IRR -12.27%

❑ Calculating Net present value (NPV)

Net present value is the difference between present value of cash inflows and the present value of cash
outflows that occur as a result of undertaking an investment project. (Javed, 2021)
NPV = -$150,000 - $103,422 + $332 + $12,354 + $31,287 + $57,018 = - $152,430

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