Question

1. The T. H. King Company has introduced a new product line that requires two work centers, A and B for manufacture. Work Center A has a current capacity of 10,000 units per year, and Work Center B is capable of 12,500 units per year. This year (year 0), sales of the new product line are expected to reach 10,000 units. Average growthis projected at an additional 1,000 units each year through year 5. Pre-tax profits are expected to be $30 per unit throughout the 5-year planning period. Two alternatives are being considered:

#1)       Expand both Work Centers A and B at the end of year 0 to a capacity of 15,000 units per year, at a total cost for both Work Centers of $200,000;

#2)       Expand Work Center A at the end of year 0 to 12,500 units per year, matching Work Center B, at a cost of $80,000, then expanding both Work Centers to 15,000 units per year at the end of year 3, at an additional cost at that time of $200,000.

Please use 15% discount rate.

a. Use the information in Table below. What is the pre-tax cash flow (net present value) for alternative #1 compared to the base case of doing nothing for the next 5 years? Please show your work in the following table.

b. What is the pre-tax cash flow (net present value) for alternative #2 compared to the base case of doing nothing for the next 5 years? Please show your work in the following table.

TABLE  |   CASH FLOWS Projection - Alternative 1
Year	Projected Demand (units/yr)			Projected Overall Capacity (units/yr)				Cash Inflow (outflow)
		Projected Work Center A Cap	Projected Work Center B Cap			Investment Cost	Earning beyond Base Case
0	10,000
1	11,000
2	12,000
3	13,000
4	14,000
5	15,000
	TABLE  |   CASH FLOWS Projection - Alternative 2 Year Projected Demand (units/yr) Projected Overall Capacity (units/yr) Cash Inflow (outflow) Projected Work Center A Cap Projected Work Center B Cap Investment Cost Earning beyond Base Case 0 10,000 1 11,000 2 12,000 3 13,000 4 14,000 5 15,000

Answer 1

a. Incremental Cash flow in case of alternative 1 from base case

	Cash	flow	projection	alternative	1
Years	projected demand (units/yr)	Projected work center A capaciy	projected work center B capacity	projected overall capacity	investment cost	earning beyond base case	Cash inflow/(outflow)
0	10000	10000	15000	10000	(200000)	0	(174000)[(200000)x0.870]
1	11000	15000	15000	15000	0	30000 [1000x30]	22680 [30000x0.756]
2	12000	15000	15000	15000	0	60000 [2000x30]	39480 [60000x0.658]
3	13000	15000	15000	15000	0	90000 [3000x30]	51480 [90000x0.572]
4	14000	15000	15000	15000	0	120000 [4000x30]	59640 [120000x0.497]
5	15000	15000	15000	15000	0	150000 [5000x30]	64800 [150000x0.432]
Total	NPV						64080

Note :

Since projected capacity for work center A and B will increase only at the end of 0th year and thus during whole year it will remain to be to be 10000 and 12500 for A & B respectively thus 10000 & 12500 units for A and B is taken during 0 period

b. Incremental cash flow in case of alternative 2 from base case

	Cash	Flow	Projection	Alternative	2
Years	projected demand (units/yr)	projected work center A capacity	projected work center B capacity	projected overall capacity	investment cost	earning beyond base case	cash inflow /(outflow)
0	10000	10000	12500	10000	(80000)	0	(69600) [(80000x0.870]
1	11000	12500	12500	12500	0	30000 (1000x30)	22680 [30000x0.756]
2	12000	12500	12500	12500	0	60000 (2000x30)	39480 [60000x0.658]
3	13000	12500	12500	12500	(200000)	75000 (2500x30)	(71500) [(200000-75000)x0.572]
4	14000	15000	15000	15000	0	120000 (4000x30)	59640 [120000x0.497]
5	15000	15000	15000	15000	0	150000 (5000x30)	64800 [150000x0.432]
Total	NPV						45500

Note :

During year 3 capacity has increased to 15000 at the end so company will be having capacity only for 12500 units that is why additional units from base case is take as 12500-10000= 2500 even when incremental demand is for 13000-10000=3000 units