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Net Present Value Project Details Starlight Industries has developed a project to produce a new product:...
Net Present Value Project Details
Starlight Industries has developed a project to produce a new product: Widgets. To develop the widgets, Starlight Industries needs to purchase a new machine that will help develop the widgets. Starliper Industries is deciding between two different machines, “New Tech” and “Standard Classic” that have the capabilities necessary to develop the widgets. Your job will be to compare the two different machines using net present value. The company has produced the following information regarding the widgets and the two machines:
-
The cost to purchase “New Tech” will be $421,000 and will have a useful life of 6 years; “New Tech” will have a salvage value of $26,000 at the end of 6 years. The cost to purchase “Standard Classic” will be $235,000 and will also have a useful life of 6 years; “Standard Classic” will have a salvage value of $5,000 at the end of 6 years.
-
Total Contribution Margin from the sale of Widgets will be different for each machine because the “Standard Classic” machine requires more variable manufacturing overhead costs. The expected contribution margin if the “New Tech” machine is chosen is the following:
The contribution margin if the “Standard Classic” is chosen is expected to be the following:
-
Working Capital of $53,000 will be required at the beginning of the production of Widgets for the “New Tech” machine, and working capital of $95,000 will be required at the beginning of the production of Widgets for the “Standard Classic” machine. For both machines the working capital will be released at the end of the project (i.e., end of year 6).
-
The yearly cost of machine maintenance will be $50,000 for the “New Tech” and will be $72,000 for the “Standard Classic” machine.
-
Other fixed costs for salaries, property taxes, and insurance, which will be the same regardless of the machine chosen, will be the following:
|
Year |
Total Contribution Margin |
|
1 |
$180,000 |
|
2 |
$300,000 |
|
3 |
$360,000 |
|
4-6 |
$440,000 |
|
Year |
Total Contribution Margin |
|
1 |
$175,000 |
|
2 |
$280,000 |
|
3 |
$355,000 |
|
4-6 |
$438,000 |
|
Year |
Total Other Fixed Costs |
|
1-2 |
$180,000 |
|
3 |
$150,000 |
|
4-6 |
$120,000 |
-
The “Standard Classic” machine will require a major overhaul that will cost $100,000 at the end of year 3 of the project. This will not apply to the “New Tech” machine.
-
The Required Rate of Return for Starliper Industries is 9%.
-
Use the “Total-Cost Approach” as described in section “Expanding the Net Present Value
Method” on page 646 of the textbook. Required:
-
Use the “NPV Project Template” Excel file on Blackboard.
-
The cells you are required to fill are the cells in the “Net Present Value Analysis” box in both the
“New Tech” and “Standard Classic” tabs.
o Every cell for each ”Cash Flows” item from “Cost of Machine” to “Total Cash Flows” for
each year (“Now” through “Year 6”) must have a value. Some cells may have a zero
value.
o The “Net Present Value” cell must be filled
o The“ProjectProfitabilityIndex”cellmustbefilled
o The cells outside of the “Net Present Value Analysis” box are for
your convenience
• You must use special Excel formulas to calculate Net Present
Value
o You may use the Present Value (pv) formula method to find the present value of the cash flows of each individual year (use cell row “Discounted CF (Optional)” for this method)
o Alternatively, you may use the Net Present Value (NPV) formula
method.
o You do not have to utilize both methods (although it may provide
a nice check).
MUST SHOW YOUR FORMULAS
Solutions
Expert Solution
| Calculation of NPV | |||||||||
| Machine : New Tech | |||||||||
| Period | Cost (A) | Contribution Margin {B} | Other Fixed Costs (C) | Yearly Costs (D) | Working Capital (E) | Major Overhaul Cost (F) | Net Cash Inflows (A-B+C+D+E+F) | P.V.F | N.P.V |
| 0 | -4,21,000 | 0 | 0 | 0 | -53000 | -4,74,000 | 1.0000 | -4,74,000 | |
| 1 | 180000 | -180000 | -50000 | 0 | -50,000 | 0.9174 | -45,872 | ||
| 2 | 300000 | -180000 | -50000 | 0 | 70,000 | 0.8417 | 58,918 | ||
| 3 | 360000 | -150000 | -50000 | 0 | 1,60,000 | 0.7722 | 1,23,549 | ||
| 4 | 440000 | -120000 | -50000 | 0 | 2,70,000 | 0.7084 | 1,91,275 | ||
| 5 | 440000 | -120000 | -50000 | 0 | 2,70,000 | 0.6499 | 1,75,481 | ||
| 6 | 440000 | -120000 | -50000 | 53000 | 3,23,000 | 0.5963 | 1,92,594 | ||
| 2,21,946 | |||||||||
| Salvage Value at Year End 6 | 26,000 | 0.5963 | 15,503 | ||||||
| Total | 2,37,449 | ||||||||
| Machine : Standard Classic | |||||||||
| Period | Cost (A) | Contribution Margin {B} | Other Fixed Costs (C) | Yearly Costs (D) | Working Capital (E) | Major Overhaul Cost (F) | Net Cash Inflows (A-B+C+D+E+F) | P.V.F | N.P.V |
| 0 | -2,35,000 | 0 | 0 | 0 | -95000 | -3,30,000 | 1.0000 | -3,30,000 | |
| 1 | 175000 | -180000 | -72000 | -77,000 | 0.9174 | -70,642 | |||
| 2 | 280000 | -180000 | -72000 | 28,000 | 0.8417 | 23,567 | |||
| 3 | 355000 | -150000 | -72000 | -100000 | 33,000 | 0.7722 | 25,482 | ||
| 4 | 438000 | -120000 | -72000 | 2,46,000 | 0.7084 | 1,74,273 | |||
| 5 | 438000 | -120000 | -72000 | 2,46,000 | 0.6499 | 1,59,883 | |||
| 6 | 438000 | -120000 | -72000 | 95000 | 3,41,000 | 0.5963 | 2,03,327 | ||
| 1,85,890 | |||||||||
| Salvage Value at Year End 6 | 5000 | 0.5963 | 2,981 | ||||||
| Total | 1,88,871 | ||||||||
| Summary: Machiner New Tech's NPV is better than Standar Classic. | |||||||||
| Profitability Index= | (NPV+ initial Investment) | ||||||||
| initial investment | |||||||||
| Machine : New Tech | Machine : Standard Classic |
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