OptiLux is considering investing in an automated manufacturing system. The system requires an initial investment of $4.6 million, has a 20-year life, and will have zero salvage value. If the system is implemented, the company will save $700,000 per year in direct labor costs. The company requires a 11% return from its investments. Using Excel, compute the internal rate of return for the proposed investment.
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OptiLux is considering investing in an automated manufacturing system. The system requires an initial investment of $4.6 million, has a 20-year life, and will have zero salvage value. If the system is implemented, the company will save $700,000 per year in direct labor costs. The company requires a 11% return from its investments.
Using Excel, compute the
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- Friedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.Roberts Company is considering an investment in equipment that is capable of producing more efficiently than the current technology. The outlay required is 2,293,200. The equipment is expected to last five years and will have no salvage value. The expected cash flows associated with the project are as follows: Required: 1. Compute the projects payback period. 2. Compute the projects accounting rate of return. 3. Compute the projects net present value, assuming a required rate of return of 10 percent. 4. Compute the projects internal rate of return.Caduceus Company is considering the purchase of a new piece of factory equipment that will cost $565,000 and will generate $135,000 per year for 5 years. Calculate the IRR for this piece of equipment. For further instructions on internal rate of return In Excel, see Appendix C.
- Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway’s president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facility is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59 – $5 – $20 = $34 million. Branch probabilities are also shown for the chance events. Analyze the decision tree to determine whether the company should undertake the R&D project. If it does, and if the R&D project is successful, what should the company do? What is the expected value of your strategy? What must the selling price be for the company to consider selling the rights to the product? Develop a risk profile for the optimal strategy.Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company’s tax rate is 25%. What is the initial investment outlay? The company spent and expensed $150,000 on research related to the new product last year. What is the initial investment outlay? Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. What is the initial investment outlay?The J.R. Ryland Computer Company is considering a plant expansion to enable the company to begin production of a new computer product. The companys president must determine whether to make the expansion a medium- or large-scale project. Demand for the new product is uncertain, which for planning purposes may be low demand, medium demand, or high demand. The probability estimates for demand are 0.20, 0.50, and 0.30, respectively. Letting x and y indicate the annual profit in thousands of dollars, the firms planners developed the following profit forecasts for the medium-and large-scale expansion projects. a. Compute the expected value for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of maximizing the expected profit? b. Compute the variance for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of minimizing the risk or uncertainty?
- Talbot Industries is considering launching a new product. The new manufacturing equipment will cost 17 million, and production and sales will require an initial 5 million investment in net operating working capital. The companys tax rate is 40%. a. What is the initial investment outlay? b. The company spent and expensed 150,000 on research related to the new product last year. Would this change your answer? Explain. c. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for 1.5 million after taxes and real estate commissions. How would this affect your answer?Mallette Manufacturing, Inc., produces washing machines, dryers, and dishwashers. Because of increasing competition, Mallette is considering investing in an automated manufacturing system. Since competition is most keen for dishwashers, the production process for this line has been selected for initial evaluation. The automated system for the dishwasher line would replace an existing system (purchased one year ago for 6 million). Although the existing system will be fully depreciated in nine years, it is expected to last another 10 years. The automated system would also have a useful life of 10 years. The existing system is capable of producing 100,000 dishwashers per year. Sales and production data using the existing system are provided by the Accounting Department: All cash expenses with the exception of depreciation, which is 6 per unit. The existing equipment is being depreciated using straight-line with no salvage value considered. The automated system will cost 34 million to purchase, plus an estimated 20 million in software and implementation. (Assume that all investment outlays occur at the beginning of the first year.) If the automated equipment is purchased, the old equipment can be sold for 3 million. The automated system will require fewer parts for production and will produce with less waste. Because of this, the direct material cost per unit will be reduced by 25 percent. Automation will also require fewer support activities, and as a consequence, volume-related overhead will be reduced by 4 per unit and direct fixed overhead (other than depreciation) by 17 per unit. Direct labor is reduced by 60 percent. Assume, for simplicity, that the new investment will be depreciated on a pure straight-line basis for tax purposes with no salvage value. Ignore the half-life convention. The firms cost of capital is 12 percent, but management chooses to use 20 percent as the required rate of return for evaluation of investments. The combined federal and state tax rate is 40 percent. Required: 1. Compute the net present value for the old system and the automated system. Which system would the company choose? 2. Repeat the net present value analysis of Requirement 1, using 12 percent as the discount rate. 3. Upon seeing the projected sales for the old system, the marketing manager commented: Sales of 100,000 units per year cannot be maintained in the current competitive environment for more than one year unless we buy the automated system. The automated system will allow us to compete on the basis of quality and lead time. If we keep the old system, our sales will drop by 10,000 units per year. Repeat the net present value analysis, using this new information and a 12 percent discount rate. 4. An industrial engineer for Mallette noticed that salvage value for the automated equipment had not been included in the analysis. He estimated that the equipment could be sold for 4 million at the end of 10 years. He also estimated that the equipment of the old system would have no salvage value at the end of 10 years. Repeat the net present value analysis using this information, the information in Requirement 3, and a 12 percent discount rate. 5. Given the outcomes of the previous four requirements, comment on the importance of providing accurate inputs for assessing investments in automated manufacturing systems.The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has an initial after-tax cost of 170,000. The project will produce 1,000 cases of mineral water per year indefinitely, starting at Year 1. The Year-1 sales price will be 138 per case, and the Year-1 cost per case will be 105. The firm is taxed at a rate of 25%. Both prices and costs are expected to rise after Year 1 at a rate of 6% per year due to inflation. The firm uses only equity, and it has a cost of capital of 15%. Assume that cash flows consist only of after-tax profits because the spring has an indefinite life and will not be depreciated. a. What is the present value of future cash flows? (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.) What is the NPV? b. Suppose that the company had forgotten to include future inflation. What would they have incorrectly calculated as the projects NPV?
- Falkland, Inc., is considering the purchase of a patent that has a cost of $50,000 and an estimated revenue producing life of 4 years. Falkland has a cost of capital of 8%. The patent is expected to generate the following amounts of annual income and cash flows: A. What is the NPV of the investment? B. What happens if the required rate of return increases?Hudson Corporation is considering three options for managing its data warehouse: continuing with its own staff, hiring an outside vendor to do the managing, or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows: If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data warehouse? What is the expected annual cost associated with that recommendation? Construct a risk profile for the optimal decision in part (a). What is the probability of the cost exceeding $700,000?I know that its the thing to do, insisted Pamela Kincaid, vice president of finance for Colgate Manufacturing. If we are going to be competitive, we need to build this completely automated plant. Im not so sure, replied Bill Thomas, CEO of Colgate. The savings from labor reductions and increased productivity are only 4 million per year. The price tag for this factoryand its a small oneis 45 million. That gives a payback period of more than 11 years. Thats a long time to put the companys money at risk. Yeah, but youre overlooking the savings that well get from the increase in quality, interjected John Simpson, production manager. With this system, we can decrease our waste and our rework time significantly. Those savings are worth another million dollars per year. Another million will only cut the payback to about 9 years, retorted Bill. Ron, youre the marketing managerdo you have any insights? Well, there are other factors to consider, such as service quality and market share. I think that increasing our product quality and improving our delivery service will make us a lot more competitive. I know for a fact that two of our competitors have decided against automation. Thatll give us a shot at their customers, provided our product is of higher quality and we can deliver it faster. I estimate that itll increase our net cash benefits by another 2.4 million. Wow! Now thats impressive, Bill exclaimed, nearly convinced. The payback is now getting down to a reasonable level. I agree, said Pamela, but we do need to be sure that its a sound investment. I know that estimates for construction of the facility have gone as high as 48 million. I also know that the expected residual value, after the 20 years of service we expect to get, is 5 million. I think I had better see if this project can cover our 14% cost of capital. Now wait a minute, Pamela, Bill demanded. You know that I usually insist on a 20% rate of return, especially for a project of this magnitude. Required: 1. Compute the NPV of the project by using the original savings and investment figures. Calculate by using discount rates of 14% and 20%. Include salvage value in the computation. 2. Compute the NPV of the project using the additional benefits noted by the production and marketing managers. Also, use the original cost estimate of 45 million. Again, calculate for both possible discount rates. 3. Compute the NPV of the project using all estimates of cash flows, including the possible initial outlay of 48 million. Calculate by using discount rates of 14% and 20%. 4. CONCEPTUAL CONNECTION If you were making the decision, what would you do? Explain.
