Question

Beacon Company is considering automating its production facility. The initial investment in automation would be $11.62 million, and the equipment has a useful life of 9 years with a residual value of $1,090,000. The company will use straight-line depreciation. Beacon could expect a production increase of 41,000 units per year and a reduction of 20 percent in the labor cost per unit.

	Current (no automation)			Proposed (automation)
	77,000 units			118,000 units
Production and sales volume	Per Unit		Total	Per Unit		Total
Sales revenue	$	96	$ ?	$	96	$ ?
Variable costs
Direct materials	$	20		$	20
Direct labor		15			?
Variable manufacturing overhead		12			12
Total variable manufacturing costs		47			?
Contribution margin	$	49	?	$	52	?
Fixed manufacturing costs			$ 1,230,000			$ 2,350,000
Net operating income			?			?

Required:
1-a. Complete the following table showing the totals.

2. Determine the project's accounting rate of return.

3. Determine the project's payback period.

4. Using a discount rate of 14 percent, calculate the net present value (NPV) of the proposed investment. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.)

5. Recalculate the NPV using a 9 percent discount rate. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.)

Answer 1

Part-1(a)
	Current (no automation)			Proposed (automation)
	77,000 units			118,000 units
Production and sales volume	Per Unit		Total	Per Unit		Total
Sales revenue	$	$96.00	$7,392,000.00	$	$96.00	$11,328,000.00
Variable costs
Direct materials	$	$20.00	$1,540,000.00	$	$20.00	$2,360,000.00
Direct labor		$15.00	$1,155,000.00		$12.00	$1,416,000.00
Variable manufacturing overhead		$12.00	$924,000.00		$12.00	$1,416,000.00
Total variable manufacturing costs		$47.00	$3,619,000.00		$44.00	$5,192,000.00
Contribution margin	$	$49.00	$3,773,000.00	$	$52.00	$6,136,000.00
Fixed manufacturing costs			$1,230,000.00			$2,350,000.00
Net operating income			$2,543,000.00			$3,786,000.00

Part-1(a)
	Current (no automation)			Proposed (automation)
	77,000 units			118,000 units
Production and sales volume	Per Unit		Total	Per Unit		Total
Sales revenue	$	$96.00	$7,392,000.00	$	$96.00	$11,328,000.00
Variable costs
Direct materials	$	$20.00	$1,540,000.00	$	$20.00	$2,360,000.00
Direct labor		$15.00	$1,155,000.00		$12.00	$1,416,000.00
Variable manufacturing overhead		$12.00	$924,000.00		$12.00	$1,416,000.00
Total variable manufacturing costs		$47.00	$3,619,000.00		$44.00	$5,192,000.00
Contribution margin	$	$49.00	$3,773,000.00	$	$52.00	$6,136,000.00
Fixed manufacturing costs			$1,230,000.00			$2,350,000.00
Net operating income			$2,543,000.00			$3,786,000.00

Part-2

Accounting Rate of Return= Incremental Net Income / Average Investment

=1243000/6355000= 19.56%

Average Investment = (11620000+1090000)/2= 6355000

Part-3

Payback period= Initial investment / Annual Cash Flow

=11620000/2413000=4.82 year

Incremental Annual Cash Flow = Increment Net Income + Depreciation

=1243000+1170000=2413000

Part-4 Computation of NPV- Beacon
Year	Cash Flow		PVAF @14%	Presetn Value
0	-$11,620,000.00		1.0000	-$11,620,000.00
1	$2,413,000.00		0.8772	$2,116,666.67
2	$2,413,000.00		0.7695	$1,856,725.15
3	$2,413,000.00		0.6750	$1,628,706.27
4	$2,413,000.00		0.5921	$1,428,689.71
5	$2,413,000.00		0.5194	$1,253,236.59
6	$2,413,000.00		0.4556	$1,099,330.34
7	$2,413,000.00		0.3996	$964,324.86
8	$2,413,000.00		0.3506	$845,899.00
9	$3,503,000.00		0.3075	$1,077,200.32
	NPV			$650,778.90
Part5 Computation of NPV- Beacon
Year	Cash Flow		PVAF @9%	Presetn Value
0	-$11,620,000.00		1.0000	-$11,620,000.00
1	$2,413,000.00		0.9174	$2,213,761.47
2	$2,413,000.00		0.8417	$2,030,973.82
3	$2,413,000.00		0.7722	$1,863,278.74
4	$2,413,000.00		0.7084	$1,709,430.03
5	$2,413,000.00		0.6499	$1,568,284.44
6	$2,413,000.00		0.5963	$1,438,793.06
7	$2,413,000.00		0.5470	$1,319,993.63
8	$2,413,000.00		0.5019	$1,211,003.33
9	$3,503,000.00		0.4604	$1,612,878.51
	NPV			$3,348,397.04