Acc206

32) Compute the NPV for the following project. The initial cost is $5,000. The net cash flows are $1,900 for four years. The net salvage value is $1,000 when the project terminates. The cost of capital is 10%.

An investment project should be accepted only if the NPV is equal to the initial cash flow.

Whenever there is a question about what assignments are due, please remember this syllabus is considered the ruling document.

S O LU T I O N TO C O R P O R AT I O N P R AC T I C E S E T

NPV: If NPV>0, accept the project [which are expected to add value to the firm], otherwise don’t bother.

(1) – (3) = total labor variance; (1) – (2) = labor price variance; and (2) – (3) = labor quantity variance.

Based on this calculation, the project should not be accepted. In general, a project should not be accepted if the net present value is below zero. The net present value of this project is -$260,676, so it should not be accepted.

In our opinion, the assumptions regarding Capacity Utilization for the new plant will have the largest impact on NPV and present the largest risk to the success of the project. The biggest driver of this risk is the limited 3 year commitment of the customer. NPV at the 9.38% discount rate for a 3 year period results in ($39,150,990). If Capacity Utilization for the new plant drops below 72.5% for an extended period of time beginning in Year 4 of the project, the 10 year NPV will likely be negative.

The ABC Company is a manufacturing company that specializes in making cedar roofing and siding shingles. The company has plans on expanding its business to include building cedar dollhouses. A controller is an individual who has responsibility for all accounting-related activities within a firm. In most organizations, the controller is the top managerial and financial accountant. The controller supervises the accounting department and assists management in interpreting and utilizing managerial accounting information. As being the new controller of the company, I have been assigned to oversee a new plan that was presented by the CEO. The plan is to reach the $3 million mark over the next three years. This plan will bring risk and

Net Present Value (NPV) calculates the sum of discounted future cash flows and subtracting that amount with the initial investment of the project. If the NPV of a project results in a positive number, the project should be undertaken. It is the most widely used method of capital budgeting. While discount rate used in NPV is typically the organization’s WACC, higher risk projects would not be factored in into the calculation. In this case, higher discount rate should be used. An example of this is when the project to be undertaken happens to be an international project where the country risk is high. Therefore, NPV is usually used to determine if a project will add value to the company. Another disadvantage of NPV method is that it is fairly complex compared to the other methods discussed earlier.

It is clear to see that throughout the project the tasks and progress were monitored very closely. The project is heavily dependent on the resources provided by its shareholders and in turn they rely on regular updates to reassure them on their investment. In the construction and building industry the methods and application of project management tools are very reliable and well tested. Therefore, it could benefit the project if the it was managed with detailed and defined practises and also follow standards set and agreed upon on a international level.

The company maintains a minimum cash balance of $50,000. All borrowing is done at the beginning of a month; any repayments are made at the end of a month.

With the introduction of a new product comes the potential for risk. Great care and thoroughness should be taken to identify as many potential risks as imaginable since although it is not always possible to control risk factors it is entirely possible to mitigate potential ill effects if a solid strategy is in place. Some risk factors identified may never actually be realized, but it is well worth having a contingency plan in place rather than running the risk of causing detriment to the financial well-being of the business.

This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.

THIS CASE DEALS WITH ONE OF THE CLASSIC MANAGERIAL DECISIONS—MAKE VERSUS BUY. MOST COURSES IN MANAGERIAL ACCOUNTING INCLUDE AT LEAST ONE “MAKE/BUY” PROBLEM TO ILLUSTRATE THE APPLICABILITY OF “RELEVANT COST ANALYSIS” IN THINKING ABOUT SUCH DECISIONS.