Question

In: Economics

Ahmad has inherited a family business of producing sodas. In his newly managing company, he has...

Ahmad has inherited a family business of producing sodas. In his newly managing company, he has a machine (Super-Soda-Maker 2000) that can produce 500 cans of soda per hour. This machine requires maintenance every year with a cost of $125,000 and increasing by $50,000 each year starting at year 3. Ahmad is deciding whether to retire 10 years from now, or 5 years from now. If he retires 10 years from now he can sell the machine for $20,000 but if he chooses to retire 5 years from now he can sell the machine for $55,000. Each can of soda is sold at $0.89. The company operates for 8 hours per day, and after considering holidays and vacations, the company works only for 200 days per year. All other operating expenses like salaries, rent, electricity, taxes, etc. are fixed costs estimated to be $100,000 per year regardless of when he will retire. MARR = 10%.

a) Should Ahmad retire in 5 years or in 10 years? Show your work. Explain why

Solutions

Expert Solution

Here,

Soda can produced per hour = 500

Number of working hours a day = 8

Number of working days in a year = 200

So soda can produced per year = 200*8*500 = 800000

Price of Can of Soda= $0.89

Yearly Revenue = 0.89*800000 = $712000

Maintainance cost in year 1 and 2 = $125,000

Maintainance cost increases by $50000 every year after that

Fixed Cost = $100,000

Salvage Value after 5 years = $55,000

Salvage Value after 10 years = $20,000

So Cash Flow if machine operated for 5 years,

28-07-2021 28-07-2022 28-07-2023 28-07-2024 28-07-2025
Year 1 Year 2 Year 3 Year 4 Year 5
Revenue 712000 712000 712000 712000 712000
Operating Cost 125000 125000 175000 225000 275000
Fixed Cost 100000 100000 100000 100000 100000
Salvage Value 55000
Cash Flow 487000 487000 437000 387000 392000

Net Present Value for 5 years,

= 487000/ (1+.1) + 487000/((1+.1)^(2))+ 437000/((1+.1)^(3))+ 387000/((1+.1)^(4))+ 392000/((1+.1)^(5))

NPV = $1681258.5

So Cash Flow if machine operated for 10 years,

28-07-2021 28-07-2022 28-07-2023 28-07-2024 28-07-2025 28-07-2026 28-07-2027 28-07-2028 28-07-2029 28-07-2030
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Revenue 712000 712000 712000 712000 712000 712000 712000 712000 712000 712000
Operating Cost 125000 125000 175000 225000 275000 325000 375000 425000 475000 525000
Fixed Cost 100000 100000 100000 100000 100000 100000 100000 100000 100000 100000
Salvage Value 20000
Cash Flow 487000 487000 437000 387000 337000 287000 237000 187000 137000 107000

Net Present Value for 10 years,

= 487000/ (1+.1) + 487000/((1+.1)^(2))+ 437000/((1+.1)^(3))+ 387000/((1+.1)^(4))+ 337000/((1+.1)^(5))+ 287000/((1+.1)^(6))+ 237000/((1+.1)^(7))+ 187000/((1+.1)^(8))+ 137000/((1+.1)^(9))+ 107000/((1+.1)^(10))

NPV = $2117321.75

Since Net present value for working for 10 years is higher, hence he should retire after 10 years


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