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Chapter 12 Case:LCH manufactures product X which it sells for $5 per unit. Variable costs of production are currently $3 per unit, and fixed costs 50c per unit. A new machine is available which would cost $90,000 but which could be used to make product X for a variable cost of only $2.50 per unit. Fixed costs, however, would increase by $7,500 per annum as a direct result of purchasing the machine. The machine would have an expected life of four years and a resale value after that time of $10,000. Sales of product X are estimated to be 75,000 units per annum. LCH expects to earn at least 12% per annum from its investments. Ignore taxation. You are required to decide whether LCH should purchase the machine.Solution:Savings are 75,000 * ($3 $2.50) = $37,500 per annum.Additional costs are $7,500 per annum.Net cash savings are therefore $30,000 per annum. (Remember, depreciation is not a cash flow and must be ignored as a “cost”.)The first step in calculating an NPV is to establish the relevant costs year by year. All future cash flows arising as a direct consequence of the decision should be taken into account. It is assumed that the machine will be sold for $10,000 at the end of year 4.Year Cash flow PV factor 12% PV of cash flow$ $0 (90,000) 1.000 (90,000)1 30,000 0.893 26,7902 30,000 0.797 23,9103 30,000 0.712 21,3604 40,000 0.636 25,440NPV = +7,500The NPV is positive and so the projec