“I know that it’s 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.” “I’m 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 factory—and it’s a small one—is $45 million. That gives a payback period of more than 11 years. That’s a long time to put the company’s money at risk.” “Yeah, but you’re overlooking the savings that we’ll 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, you’re the marketing manager—do 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. That’ll give us a shot at their customers, provided our product is of higher quality and we can deliver it faster. I estimate that it’ll increase our net cash benefits by another $2.4 million.” “Wow! Now that’s 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 it’s 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.

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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
Publisher: Cengage Learning
ISBN: 9781337115773
BuyFind

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
Publisher: Cengage Learning
ISBN: 9781337115773
Chapter 12, Problem 50P
Textbook Problem

“I know that it’s 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.”

 “I’m 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 factory—and it’s a small one—is $45 million. That gives a payback period of more than 11 years. That’s a long time to put the company’s money at risk.”

“Yeah, but you’re overlooking the savings that we’ll 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, you’re the marketing manager—do 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. That’ll give us a shot at their customers, provided our product is of higher quality and we can deliver it faster. I estimate that it’ll increase our net cash benefits by another $2.4 million.”

“Wow! Now that’s 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 it’s 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. 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. 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. 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. 4. CONCEPTUAL CONNECTION If you were making the decision, what would you do? Explain.

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Chapter 12 Solutions

Managerial Accounting: The Cornerstone of Business Decision-Making
Ch. 12 - Explain how the NPV is used to determine whether a...Ch. 12 - The IRR is the true or actual rate of return being...Ch. 12 - Explain what a postaudit is and how it can provide...Ch. 12 - Explain why NPV is generally preferred over IRR...Ch. 12 - Suppose that a firm must choose between two...Ch. 12 - Capital investments should a. always produce an...Ch. 12 - To make a capital investment decision, a manager...Ch. 12 - Mutually exclusive capital budgeting projects are...Ch. 12 - An investment of 6,000 produces a net annual cash...Ch. 12 - An investment of 1,000 produces a net cash inflow...Ch. 12 - The payback period suffers from which of the...Ch. 12 - The ARR has one specific advantage not possessed...Ch. 12 - An investment of 2,000 provides an average net...Ch. 12 - If the NPV is positive, it signals a. that the...Ch. 12 - NPV measures a. the profitability of an...Ch. 12 - NPV is calculated by using a. the required rate of...Ch. 12 - Using NPV, a project is rejected if it is a. equal...Ch. 12 - If the present value of future cash flows is 4,200...Ch. 12 - Assume that an investment of 1,000 produces a...Ch. 12 - Which of the following is not true regarding the...Ch. 12 - Using IRR, a project is rejected if the IRR a. is...Ch. 12 - A postaudit a. is a follow-up analysis of a...Ch. 12 - Postaudits of capital projects are useful because...Ch. 12 - For competing projects, NPV is preferred to IRR...Ch. 12 - Assume that there are two competing projects, A...Ch. 12 - Payson Manufacturing is considering an investment...Ch. 12 - Accounting Rate of Return Uchdorf Company invested...Ch. 12 - Net Present Value Snow Inc. has just completed...Ch. 12 - Internal Rate of Return Lisun Company produces a...Ch. 12 - NPV and IRR, Mutually Exclusive Projects Hunt Inc....Ch. 12 - Payback Period Folsom Advertising, Inc. is...Ch. 12 - Accounting Rate of Return Cannon Company invested...Ch. 12 - Net Present Value Talmage Inc. has just completed...Ch. 12 - Internal Rate of Return Richins Company produces...Ch. 12 - NPV and IRR, Mutually Exclusive Projects Techno...Ch. 12 - Payback Period Each of the following scenarios is...Ch. 12 - Accounting Rate of Return Each of the following...Ch. 12 - Net Present Value Each of the following scenarios...Ch. 12 - Internal Rate of Return Each of the following...Ch. 12 - Net Present Value and Competing Projects Spiro...Ch. 12 - Payback, Accounting Rate of Return, Net Present...Ch. 12 - Payback, Accounting Rate of Return, Present Value,...Ch. 12 - Net Present Value, Basic Concepts Wise Company is...Ch. 12 - Solving for Unknowns Each of the following...Ch. 12 - Net Present Value versus Internal Rate of Return...Ch. 12 - Basic Net Present Value Analysis Jonathan Butler,...Ch. 12 - Net Present Value Analysis Emery Communications...Ch. 12 - Basic Internal Rate of Return Analysis Julianna...Ch. 12 - Net Present Value, Uncertainty Ondi Airlines is...Ch. 12 - Review of Basic Capital Budgeting Procedures Dr....Ch. 12 - Net Present Value and Competing Alternatives...Ch. 12 - Kildare Medical Center, a for-profit hospital, has...Ch. 12 - Foster Company wants to buy a numerically...Ch. 12 - Cost of Capital, Net Present Value Leakam Companys...Ch. 12 - I know that its the thing to do, insisted Pamela...Ch. 12 - Newmarge Products Inc. is evaluating a new design...Ch. 12 - Patterson Company is considering two competing...Ch. 12 - Patterson Company is considering two competing...Ch. 12 - Manny Carson, certified management accountant and...Ch. 12 - Shaftel Ready Mix is a processor and supplier of...Ch. 12 - NoFat manufactures one product, olestra, and sells...Ch. 12 - NoFat manufactures one product, olestra, and sells...Ch. 12 - NoFat manufactures one product, olestra, and sells...Ch. 12 - NoFat manufactures one product, olestra, and sells...Ch. 12 - NoFat manufactures one product, olestra, and sells...

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