Question

THIS LOOKS LIKE A LONG PROBLEM BUT IT'S JUST A LOT OF WORDS- THE QUESTIONS ARE JUST CALCULATIONS

If capacity increased, French estimated that sales revenues would rise by at least $50,000 per month due to unmet demand and increased efficiency. The company’s margins on the additional revenues were expected to be 35%

. French saw three viable options to increase capacity:

1. Purchase an additional CNC machine for cash,

2. Finance the purchase of an additional CNC machine, or

3. Add a third shift (a night shift) to better utilize the two CNC machines Peregrine already owned.

French considered the details of each option, keeping in mind that for long-term projects he would use a discount rate of 7%. OPTION 1: PURCHASE A NEW CNC MACHINE WITH CASH

Long term projects he would use a discount rate of 7% French’s preliminary research revealed that the cost of the new equipment would be $142,000. He also estimated that there would be increased out-of-pocket operating costs of $10,000 per month if a new machine were brought online. After five years, the machine would have a salvage value of $40,000. Although Peregrine did not have the cash readily available to make the purchase, French believed that with a small amount of cash budgeting and planning, this option would be feasible.

OPTION 2: FINANCE THE PURCHASE OF A NEW CNC MACHINE The company selling the CNC machine also offered a leasing option. The terms of the lease included a down payment of $50,000 and monthly payments of $2,200 for five years. After five years, the equipment could be purchased for $1. The operating costs and salvage values would be the same as option 1, the purchasing option.

OPTION 3: ADD A THIRD SHIFT

his initial plan was for the night shift to run as a “skeleton crew” with the primary purpose of keeping the CNC machines operational for 24 hours. He believed that adding a third shift would produce the same increase in revenue as adding a new CNC machine to his existing shifts. He estimated that adding a third shift would create $12,000 in additional monthly out-of-pocket operating costs, but no $ on machinery.

THE ONLY QUESTIONS I NEED HELP WITH ARE BELOW:

2. Compute and compare the net present value and payback period of each option.

4. Rounding to the nearest 1%, at what discount rate does leasing produce a higher net present value than paying cash?

Answer 1

2. NET PRESENT VALUE OF ALL 3 OPTIONS:

SInce there is no initial cash outflow in case of Option 2 and 3 and cash outlfows occur over a period of 5 years, the payback period is not calculated.

Option 3 is more feasible than Option 1 and 2. based on NPV.

Q4. We can note that option 2 NPV is lesser than Option1, By trial and error, we can see that a discount rate of 5% would be the applicable rate for Option 2 to have more NPV than Option 1.