Mr. Baker would like to explore options to improve the financial performance of the vortex manipulator...

Mr. Baker would like to explore options to improve the financial performance of the vortex manipulator product line. He has looked into two possible alternatives: improving automation and eliminating excess capacity. The company’s standard discount rate for investments is 15%, and additional information regarding costs are below.

Per Unit Production Costs	Vortex Manipulators
Sales (units)	1,000
Selling Price	$ 1,200.00 each

Direct Materials per Unit	$ 290.00
Direct Labor per Unit	340.00
Manufacturing Overhead per Unit	270.00
Total Variable Expenses per unit	$ 900.00
Contribution Margin Ratio	25.00%

Project 1: Automation

The process of producing the vortex manipulators could be automated to reduce labor costs. The additional equipment for the automation will cost $250,000 and has a useful life of 5 years with a salvage value of $25,000. If the automation is implemented, labor costs for the Vortex Manipulators would be reduced by 20%.

Project 2: Reducing Capacity

The equipment to produce vortex manipulators has a total capacity of 1,500 units even though only 1,000 are currently being produced. If the total capacity were reduced to 1,000 units, the excess equipment could be sold for immediately for $140,000. This would also reduce the annual depreciation by $50,000 and decrease efficiency such that both labor cost would increase by $10 per unit and overhead by $30 per unit.

What is the net present value of each project?

Project 1	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment
Annual Cost Savings
Salvage Value
Net Cash Inflows (Outflows)
Discount Rate	1.00000	0.86957	0.75614	0.65752	0.57175	0.49718
Present Value of Cash Flows

Project 1	Now	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment
Annual Cost Savings
Salvage Value
Net Cash Inflows (Outflows)
Discount Rate	1.00000	0.86957	0.75614	0.65752	0.57175	0.49718
Present Value of Cash Flows

	Option 1	Option 2
Net Present Value

Gallifrey Gadgets, Inc. has the capital and ability to implement both, either, or none of these options. Which should they choose to implement and why?

Expert Solution

ekkarill92 answered 2 years ago

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