Question

Submit a written paper which is 3-4 pages in length

Please describe the circumstances of the following case study and recommend a course of action. Explain your approach to the problem, perform relevant calculations and analysis, and formulate a recommendation. Ensure your work and recommendation are thoroughly supported.

Case Study:

A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods. The details for each option are provided below:

Option 1                                                                                                       

• $65,000 for equipment with useful life of 7 years and no salvage value.                                                                            
• Maintenance costs are expected to be $2,700 per year and increase by 3% in Year 6 and remain at that rate.                                       
• Materials in Year 1 are estimated to be $15,000 but remain constant at $10,000 per year for the remaining years.                              
• Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after.          

Revenues are estimated to be:

Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
-	75,000	100,000	125,000	150,000	150,000	150,000

Option 2

• $85,000 for equipment with useful life of 7 years and a $13,000 salvage value
• Maintenance costs are expected to be $3,500 per year and increase by 3% in Year 6 and remain at that rate.
• Materials in Year 1 are estimated to be $20,000 but remain constant at $15,000 per year for the remaining years.
• Labor is estimated to start at $60,000 in Year 1, increasing by 3% each year after.

Revenues are estimated to be:

Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
-	80,000	95,000	130,000	140,000	150,000	160,000

The company’s required rate of return and cost of capital is 8%.

Management has turned to its finance and accounting department to perform analyses and make a recommendation on which option to choose. They have requested that the three main capital budgeting calculations be done: NPV, IRR, and Payback Period for each option.

For this assignment, compute all required amounts and explain how the computations were performed. Evaluate the results for each option and explain what the results mean. Based on your analysis, recommend which option the company should pursue.

Note:

Please do not copy the answers already here for me. I saw it before posting.

Please do not plagiarise

Please answer all parts.

Superior papers will:

• Perform all calculations correctly.
• Articulate how the calculations were performed, including from where values used in the calculations were obtained.
• Evaluate the results computed and explain the meaning of the results, including why certain measurements are more accurate than others.
• Recommend which option to pursue, supported by well-thought-out rationale, and considering any other factors that could impact the recommendation.

Answer 1

Option 1:

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Revenue	-	75,000	1,00,000	1,25,000	1,50,000	1,50,000	1,50,000
Maintenance cost (3% increase in 6th year)	2,700	2,700	2,700	2,700	2,700	2,781	2,781
Materials	15,000	10,000	10,000	10,000	10,000	10,000	10,000
Labor	70,000	72,100	74,263	76,491	78,786	81,149	83,584
Net Operating income/ (loss)	-87,700	-9,800	13,037	35,809	58,514	56,070	53,635
Cost of capital	8%	8%	8%	8%	8%	8%	8%
PV factor @ 8%	0.9259	0.8573	0.7938	0.7350	0.6806	0.6302	0.5835
Present value	-81,204	-8,402	10,349	26,321	39,824	35,333	31,296	53,517

a. Net present value

= -Initial outflow + Present value of income from equipment

= -65000 + 53517

= -11,483

b. IRR

= return / cost

Implies, if x is the required IRR ,

X = -11483/65000

X = -17%

c. Payback period

= since doesn’t recover the actual cost itself, payback is not there

Option 2

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Revenue	-	80,000	95,000	1,30,000	1,40,000	1,50,000	1,60,000
Maintenance cost (3% increase in 6th year)	3,500	3,500	3,500	3,500	3,500	3,605	3,605
Materials	20,000	15,000	15,000	15,000	15,000	15,000	15,000
Labor	60,000	61,800	63,654	65,564	67,531	69,556	71,643
Net Operating income/ (loss)	-83,500	-300	12,846	45,936	53,969	61,839	69,752
Salvage value of equipment							13,000
Cost of capital	8%	8%	8%	8%	8%	8%	8%
PV factor @ 8%	0.9259	0.8573	0.7938	0.7350	0.6806	0.6302	0.5835
Present value	-77,315	-257	10,198	33,765	36,731	38,969	48,285	90,375

                               

a. Net present value

= -Initial outflow + Present value of income from equipment

= -85000 + 90375

= 5375

b. IRR

= return/ cost

Implies, if x is the required IRR ,

X = 5375/85000

X = 6.32%

c. Payback period

= Investment / annual cash flow

= 85000/(90375/7)

= 6.58 years

The company should pursue option 2 as there is positive NPV and IRR and there is payback of the investment