Question

Springfield Manufacturing Co. is considering the investment of $60,000 in a new machine. The machine will generate cash flow of $7,500 per year for each year of its 15 year life and will have a salvage value of $4,000 at the end of its life. Springfield's cost of capital is 10%. (a.) Calculate the net present value of the proposed investment. Ignore income taxes, and round all answers to the nearest $1. (b.) Calculate the present value ratio of the investment. (c.) What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer. (d.) Calculate the payback period of the investment.

2The following product line information is for the Swiss Watch Company. The company is considering dropping its Children's product line due to poor operating income performance. Fixed expenses are allocated to each product line based on sales revenue. Watch Products Men’s Women’s Children’s Sales $ 30,000 $ 50,000 $ 40,000 Variable expenses 10,000 15,000 25,000 Fixed expenses 15,000 25,000 20,000 Operating income $ 5,000 $ 10,000 $ (5,000 ) (a.) Calculate the effect on the Swiss Company's operating income if the Children's watch product line is discontinued. Comment on your analysis. (b.) Assume that Swiss Company discontinues its Children's product line. Calculate the total operating income for the Swiss Company.

Answer 1

1.

	Cash Flows
Y0	-60,000
Y1	7,500
Y2	7,500
Y3	7,500
Y4	7,500
Y5	7,500
Y6	7,500
Y7	7,500
Y8	7,500
Y9	7,500
Y10	7,500
Y11	7,500
Y12	7,500
Y13	7,500
Y14	7,500
Y15	11,500	Inlcuding Salvage Value
Cost of Capital	10%
NPV	-1,815.31	=NPV(10%, all values)
Present Value of Cash Generated	58,003.16	=NPV(10%, Cash Flow from Y1 to Y15)
Present Value Ratio	0.97	= PV of Cash Generated/ Investment
IRR	9.43%	=IRR(All Cash Flows)
Payback Period	8 Years	in 8 years, we are able to recover investment

IRR is 9.43% and is lower than the cost of capital which is 10%. Since IRR is lower than cost of capital, it is not a beneficial projct ot undertake and the same is shown by -ve NPV of the project

2.

(A) on stopping the CHildre's Watch division, the sals from the division stops and the variable costs stop too. But the fixed costs will not stop since they have already been invested and should therefore be one of the costs which are still exisitng even after closure of the firm and should be allocated to the other divisions's fixed costs.

(B)

	Men's	Women's	Children's	Total
Sales	30,000	50,000	40,000	120,000
Variable Expenses	10,000	15,000	25,000	50,000
Fixed Expenses	15,000	25,000	20,000	60,000
Operating Income	5,000	10,000	-5,000	10,000
On Stopping Children's Segment	Men's	Women's	Children's	Total
Sales	30,000	50,000	0	80,000
Variable Expenses	10,000	15,000	0	25,000
Fixed Expenses	25,000	35,000	0	60,000	Fixed Cost Allocated Overall to both divisions
Operating Income	-5,000	0	0	-5,000

Hence unless and until the company has a plan to stp the fixed costs too, stopping the children's division may be foolish thing to do