Question
In: Finance
A company is considering two alternative methods of producing a new product. The relevant data concerning...
| A company is considering two alternative methods of producing a new product. The relevant data concerning the alternatives appear below: | ||||||||
| Alternative | Alternative | |||||||
| I | II | |||||||
| Initial investment | $64,000 | $120,000 | ||||||
| Annual receipts | $50,000 | $60,000 | ||||||
| Annual disbursements | $20,000 | $12,000 | ||||||
| Annual depreciation | $16,000 | $20,000 | ||||||
| Expected life | 4 yrs | 6 yrs | ||||||
| Salvage value | 0 | 0 | ||||||
| At the end of the useful life of whatever equipment is chosen the product will be discontinued. The company's tax rate is 50 percent and the discount rate is 10 percent. | ||||||||
|
a. Calculate the net present value of each alternative. |
||||||||
|
b. Calculate the benefit cost ratio for each alternative. |
||||||||
|
c. Calculate the internal rate of return for each alternative. |
||||||||
|
d. If the company is not under capital rationing which alternative should be chosen? Why? |
||||||||
| e. Again assuming no capital rationing, suppose the company plans to produce the product indefinitely rather than quit when the equipment wears out. Which alternative should the company select? Why? | ||||||||
| f. If the company is experiencing severe capital rationing, and plans to terminate production when the equipment wears out, would any of your answers above change? | ||||||||
Solutions
Expert Solution
a. Calculate the net present value of each alternative @ Discount rate of 10% is as follows
Calculation of Discount Rates
1-4 - Annuity Factor = 1/(1+r)^4 = 1/ (1.1) ^ 4 = 3.1699
1-6 - Annuity Factor = 1/(1+r)^6 = 1/ (1.1) ^ 6 = 4.3553
NPV for Project I
| Year/s | Cash Flow | Cash In / (Out) | Tax @ 50% | Cash Flow After Tax | Discount Rate @10% | Discounted Cash Flow |
| 0 | Initial | (64,000.00) | NA | (64,000.00) | 1.00 | (64,000.00) |
| 1-4 | Annual Receipts | 50,000.00 | 25,000.00 | 25,000.00 | 3.1699 | 79,247.50 |
| 1-4 | Annual disbursements | (20,000.00) | (10,000.00) | (10,000.00) | 3.1699 | (31,699.00) |
| 1-4 | Tax savings on Depreciation | 16,000.00 | 8,000.00 | 8,000.00 | 3.1699 | 25,359.20 |
| NPV | 8,907.70 |
NPV for Project II
| Year/s | Cash Flow | Cash In / (Out) | Tax @ 50% | Cash Flow After Tax | Discount Rate @10% | Discounted Cash Flow |
| 0 | Initial | (120,000.00) | NA | (120,000.00) | 1.00 | (120,000.00) |
| 1-6 | Annual Receipts | 60,000.00 | 30,000.00 | 30,000.00 | 4.3553 | 130,659.00 |
| 1-6 | Annual disbursements | (12,000.00) | (6,000.00) | (6,000.00) | 4.3553 | (26,131.80) |
| 1-6 | Tax savings on Depreciation | 20,000.00 | 10,000.00 | 10,000.00 | 4.3553 | 43,553.00 |
| NPV | 28,080.20 |
b. Calculate the benefit cost ratio for each alternative
for Project I
| Year | Cash Flow | Cash In / (Out) | Tax @ 50% | Cash Flow After Tax | Discount Rate @10% | Discounted Cash Flow |
| Cost | ||||||
| 0 | Initial | 64,000.00 | NA | 64,000.00 | 1.0000 | 64,000.00 |
| 1-4 | Annual disbursements | 20,000.00 | 10,000.00 | 10,000.00 | 3.1699 | 31,699.00 |
| Discounted Cost | 95,699.00 | |||||
| Benefit | ||||||
| 1-4 | Annual Receipts | 50,000.00 | 25,000.00 | 25,000.00 | 3.1699 | 79,248.00 |
| 1-4 | Tax savings on Depreciation | 16,000.00 | 8,000.00 | 8,000.00 | 3.1699 | 25,359.00 |
| Discounted Benefit | 104,607.00 | |||||
| The Benefit Cost is calculated by dividing the total discounted value of benefits by the total discounted value of cost | ||||||
| Therefore | 1.0931 | 104607 / 95699 | ||||
for project II
| Year | Cash Flow | Cash In / (Out) | Tax @ 50% | Cash Flow After Tax | Discount Rate @10% | Discounted Cash Flow |
| Cost | ||||||
| 0 | Initial | 120,000.00 | NA | 120,000.00 | 1.0000 | 120,000.00 |
| 1-6 | Annual disbursements | 12,000.00 | 6,000.00 | 6,000.00 | 4.3553 | 26,132.00 |
| Discounted Cost | 146,132.00 | |||||
| Benefit | ||||||
| 1-6 | Annual Receipts | 60,000.00 | 30,000.00 | 30,000.00 | 4.3553 | 130,659.00 |
| 1-6 | Tax savings on Depreciation | 20,000.00 | 10,000.00 | 10,000.00 | 4.3553 | 43,553.00 |
| Discounted Benefit | 174,212.00 | |||||
| The Benefit Cost is calculated by dividing the total discounted value of benefits by the total discounted value of cost | ||||||
| Therefore | 1.1922 | 174212 / 146132 | ||||
c. Calculate the internal rate of return for each alternative.
The internal rate of return on an investment or project is the the net present value of all cash flows (both positive and negative) from the investment equal to zero
The Discounted Cash Flow for Project I @ 10% = 8,907.7
The Discounted Cash Flow for Project I @ 16.28% = 0
Therefore the IRR = 16.28%
The Discounted Cash Flow for Project II @ 10% = 28,080
The Discounted Cash Flow for Project II @ 17.649% = 0
Therefore the IRR = 17.649%
d. If the company is not under capital rationing which alternative should be chosen
The Project II is the best alternative because it has the highest NPV, Benefit cost ratio and also IRR
jeff jeffy answered 2 years agoRelated Solutions
A company is considering two alternative methods of producing a new product. The relevant data concerning...
A company is considering two alternative methods of producing a
new product. The relevant data concerning the alternative are
presented below.
Alternative 1
Alternative 2
Initial investment
$64,000
$120,000
Annual Receipts
$50,000
$60,000
Annual Disbursements
$20,000
$12,000
Annual Depreciation
$16,000
$20,000
Expected Life
4 years
6 years
Salvage Value
0
0
At the end of the useful life of whatever equipment is chosen
the product will discontinue. The company's tax rate is 50% and its
cost of capital is 10%....
The Jackson Company is considering producing a new product. It has recently completed a $500,000 two-year...
The Jackson Company is considering producing a new product. It
has recently completed a $500,000 two-year market study to judge
the likely popularity of the new product. Based on the results of
the study, Jackson has estimated that 20,000 units of its new
product can be sold annually over the next eight years at a price
of $8,604 each. Variable costs per unit are $7,520 and fixed costs
total $11.63 million. Working capital specifically for this project
is estimated to...
A company is considering three alternative prices for a new product it plans to introduce. the...
A company is considering three alternative prices for a new
product it plans to introduce. the estimate of price and quantity
demanded are: with a price of $100 per unit the demand will be
50,000 units; with a price of $150 per unit the demand will be
35,000 units; and with a price of $200 per unit the demand will be
20,000 units. Fixed costs are $2,000,000 and variable cost is $50
per unit. What is the profit when the...
Exercise 6-13 Helena Company manufactures and sells two products. Relevant per unit data concerning each product...
Exercise 6-13
Helena Company manufactures and sells two products. Relevant per
unit data concerning each product follow.
Product Basic Deluxe Selling price $45 $51
Variable costs $30.60 $23.00 Machine hours 0.40 0.80
Compute the contribution margin per machine hour for each
product.
(Round answers to 0 decimal places, e.g. 5,275.)
Basic Deluxe Contribution margin per machine hour $ $ If 1,090
additional machine hours are available, which product should Helena
manufacture?
Calculate total contribution margin if the additional 1,090
hours...
Colorado Springs Technology must choose between two methods of producing a new product. The initial costs...
Colorado Springs Technology must choose between two methods of
producing a new product. The initial costs and year-end cash flow
are as follows:
Year
0
1
2
3
4
5
Method A
--$1,000,000
210,000
250,000
300,000
525,000
600,000
Method B
--$1,000,000
410,000
375,000
475,000
225,000
195,000
The company’s WACC is 10 percent. Calculate the NPV, IRR &
MIRR for each method.
Joe’s Technology must choose between two repeatable methods of producing a new product. The initial costs...
Joe’s Technology must choose between two repeatable
methods of producing a new product. The initial costs and year-end
cash benefits are as follows:
Year
0
1
2
3
4
5
Method
M
-$1,500,000
600,000
750,000
550,000
200,000
Method
N
-$2,500,000
1,200,000
950,000
700,000
400,000
300,000
Assume all cash flows occur at year-end and the
company’s required return is 6.57 percent.
Please compute the net present value ______________ and
the equivalent annuity ________________ for Method...
Joe’s Technology must choose between two repeatable methods of producing a new product. The initial costs...
Joe’s Technology must choose between two repeatable
methods of producing a new product. The initial costs and year-end
cash benefits are as follows:
Year
0
1
2
3
4
5
Method
M
-$1,500,000
600,000
750,000
550,000
200,000
Method
N
-$2,500,000
1,200,000
950,000
700,000
400,000
300,000
Assume all cash flows occur at year-end and the
company’s required return is 6.57 percent.
Please compute the net present value ______________ and
the equivalent annuity ________________ for Method...
A company manufactures and sells two products: Product A1 and Product C4. Data concerning the expected...
A company manufactures and sells two products: Product A1 and
Product C4. Data concerning the expected production of each product
and the expected total direct labor-hours (DLHs) required to
produce that output appear below:
Expected Production
Direct Labor-Hours Per Unit
Total Direct Labor-Hours
Product A1
300
4.0
1,200
Product C4
600
2.0
1,200
Total direct labor-hours
2,400
The direct labor rate is $25.90 per DLH. The direct materials
cost per unit is $285 for Product A1 and $244 for Product...
A company manufactures and sells two products: Product A1 and Product C4. Data concerning the expected...
A company manufactures and sells two products: Product A1 and
Product C4. Data concerning the expected production of each product
and the expected total direct labor-hours (DLHs) required to
produce that output appear below:
Expected Production
Direct Labor-Hours Per Unit
Total Direct Labor-Hours
Product A1
100
2.0
200
Product C4
200
1.0
200
Total direct labor-hours
400
The direct labor rate is $29.70 per DLH. The direct materials
cost per unit is $263 for Product A1 and $266 for Product...
Suppose that a person is considering an investment in a new product. The cost of producing...
Suppose that a person is considering an investment in a new
product. The cost of producing and marketing the product is
estimated to be $6 000. Three possible outcomes can result from
this investment:
The product can be extremely successful and yield a net profit
of $24,000.
The product can be moderately successful and yield a net profit
of $12,000.
The product can be unsuccessful, in which case the loss will be
equal to the initial cost of producing and...
ADVERTISEMENT
ADVERTISEMENT
Latest Questions
- Parallel Arrays This question is in MindTap Cengage Summary In this lab, you use what you...
- 5. You have invested 30 percent of your portfolio in Jacob, Inc., 40 percent is Bella...
- JAVA Write a test program that prompts the user to enter a series of integers and...
- (2) Cite an example on how organizations like Google, Facebook, Youtube etc collect data for image...
- The legal landscape is perpetually changing. Psychologists must remain abreast of these changes to avoid potentially...
- We are evaluating a project that costs $1.68 million, has a six-year life, and has no...
- In C++ Having call-by-reference allows one to use storeback parameters, i.e., parameters whose values are transmitted...
ADVERTISEMENT