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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Net Present Value and Competing Alternatives

Stillwater Designs has been rebuilding Model 100, Model 120, and Model 150 Kicker sub-woofers that were returned for warranty action. Customers returning the subwoofers receive a new replacement. The warrant)' returns are then rebuilt and resold (as seconds). Tent sales are often used to sell the rebuilt speakers. As part of the rebuilding process, the speakers are demagnetized so that metal pieces and shavings can be removed. A demagnetizing (demag) machine is used to achieve this objective. A product design change has made the most recent Model 150 speakers too tall for the demag machine. They no longer fit in the demag machine.

Stillwater Designs is currently considering two alternatives. First, a new demag machine can be bought that has a different design, eliminating the fit problem. The cost of this machine is $600,000, and it will last 5 years. Second, Stillwater can keep the current machine and sell the 150 speakers for scrap, using the old demag machine for the Model 100 and 120 speakers only. A rebuilt speaker sells for $295 and costs $274.65 to rebuild (for materials, labor, and overhead cash outlays). The $274.65 outlay includes the annual operating cash effects of the new demag machine. If not rebuilt, the Model 150 speakers can be sold for $4 each as scrap. There are 10,000 Model 150 warranty returns per year. Assume that the required rate of return is 10%.

Required:

  1. 1. Determine which alternative is the best for Stillwater Designs by using NPV analysis.
  2. 2. CONCEPTUAL CONNECTION Determine which alternative is best for Stillwater Designs by using an IRR analysis. Explain why NPV analysis is a better approach.

1.

To determine

Identify the best alternative for SD using NPV analysis.

Explanation

Net Present Value:

The remaining balance of the present value of a project’s inflows and outflows is known as net present value (NPV). It is a discounting model of capital investment decision. A project with a positive NPV increases the wealth of a firm whereas a project with a negative NPV decreases the wealth of a firm.

Use the following formula to calculate NPV for rebuild alternative:

NPV=(Cashflow×Discountfactor)Investment

Substitute $203,5001 for cash flow, 3.79079 for discount factor and $600,000 for investment in the above formula.

NPV=($203,500×3.79079)$600,000=$771,426$600,000=$171,426

Therefore, NPV of rebuild alternative is $171,426.

Use the following formula to calculate NPV for scrap alternative:

NPV=(Cashflow×Discountfactor)Investment

Substitute $40,0002 for cash flow, 3.79079 for discount factor and $0 for investment in the above formula.

NPV=($40,000×3

2.

To determine

Identify the best alternative for SD using IRR analysis. Explain the reason of NPV being a better approach.

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