BuyFindarrow_forward

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
15 views

“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.

1.

To determine

Calculate NPV of the project with discount rate of 14% and20%.

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.

Calculate NPV of the project with 14% discount rate:

Year

Cash Flow($)

A

Discount Factor

B

Present Value($)

(A×B)

0(45,000,000)1.00000(45,000,000)
1-204,000,0006.6231326,492,520
205,000,0000.07276363,800
NPV  (18,143,680)

Table (1)

Therefore, NPV of the project is ($18,143,680)

2.

To determine

Calculate NPV of the project with the use of additional benefits. Use discount rate as 14% and 20%.

3.

To determine

Compute NPV of the project with an initial outlay of $48 million. Use discount rate as 14% and 20%.

4.

To determine

State the recommendation with regard to the decision.

Still sussing out bartleby?

Check out a sample textbook solution.

See a sample solution

The Solution to Your Study Problems

Bartleby provides explanations to thousands of textbook problems written by our experts, many with advanced degrees!

Get Started

Additional Business Solutions

Find more solutions based on key concepts

Show solutions add

Why is productivity important?

Essentials of Economics (MindTap Course List)

Define the term product

MKTG 12:STUDENT ED.-TEXT

Why is understanding motivation important?

Foundations of Business (MindTap Course List)

PAYBACK PERIOD Refer to Problem 11-1. What is the projects payback?

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)