Campus Print Shop is thinking of purchasing a new, modern copier that automatically collates pages. The machine would cost $22,000 cash. A service contract on the machine, considered a must because of its complexity, would be an additional $200 per month. The machine is expected to last eight years and have a resale value of $4,000. By purchasing the new machine, Campus would save $450 per month in labor costs and $100 per month in materials costs due to increased efficiency. Other operating costs are expected to remain the same. The old copier would be sold for its scrap value of $1,000. Campus requires a return of 14% on its capital investments.
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To determine the net present value (NPV) of purchasing the new copier, we need to calculate the present value of all the cash flows associated with the purchase.
First, let's calculate the annual savings in labor costs and materials costs, as well as the salvage value of the copier at the end of its useful life. We'll then discount these cash flows back to the present value using the desired rate of return of 14%.
Annual Savings in Labor Costs: $450 per month * 12 months = $5,400 per year
Present Value of Labor Cost Savings: $5,400 / (1 + 14%)^1 = $4,736.84
Annual Savings in Materials Costs: $100 per month * 12 months = $1,200 per year
Present Value of Materials Cost Savings: $1,200 / (1 + 14%)^1 = $1,052.63
Salvage Value: $4,000 / (1 + 14%)^8 = $1,302.50
Next, let's calculate the present value of the service contract, which is $200 per month for 8 years:
Present Value of Service Contract: $200 * 12 months * 8 years / (1 + 14%)^1 = $1,339.33
Now, let's calculate the present value of the initial investment and the scrap value of the old copier:
Present Value of Initial Investment: -$22,000 (negative because it's a cash outflow)
Present Value of Scrap Value of Old Copier: $1,000 / (1 + 14%)^1 = $877.19 (negative because it's a cash inflow)
Finally, we can calculate the NPV by summing up all the present values:
NPV = Present Value of Labor Cost Savings + Present Value of Materials Cost Savings + Present Value of Service Contract + Present Value of Scrap Value of Old Copier + Present Value of Initial Investment
NPV = $4,736.84 + $1,052.63 + $1,339.33 + (-$877.19) + (-$22,000) = -$14,748.39
The NPV of purchasing the new copier is -$14,748.39. This means that the investment would result in a negative return at the desired rate of return of 14%. Therefore, based on the NPV analysis, purchasing the new copier would not be a financially viable decision for Campus Print Shop.