Adequate information:
Rent = $75,000
Building modification for Product A = $115,000
Building modification for Product B = $160,000
Initial cash outlay for equipment (Equipment) for Product A = $340,000
Initial cash outlay for equipment (Equipment) for Product B = $345,000
Estimated useful life of Product A = 15 years
Estimated useful life of Product B = 15 years
Annual pretax cash revenue (Revenue) of Product A = $275,000
Annual pretax cash revenue (Revenue) of Product B = $295,000
Annual pretax expenditure (Expenditure) of Product A = $115,000
Annual pretax expenditure (Expenditure) of Product B = $130,000
Restoration cost of Product A = $75,000
Restoration cost of Product B = $85,000
Tax rate = 21%, 0.21
Required rate of return, r = 12% or 0.12
To recommend: The product that should be chosen by the company.
Introduction:
The decision criteria of net present value are that in the case of the mutually exclusive project, the project having the higher net present value should be selected.
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CORPORATE FINANCE - CONNECT ACCESS
- 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.arrow_forwardHome Garden Inc. is considering the construction of a distribution warehouse in West Virginia to service its east coast stores based on the following estimates: a. Determine the net present value of building the warehouse, assuming a construction cost of 20,000,000, an annual net cost savings of 4,000,000, and a desired rate of return of 14%. Use the present value tables provided in Appendix A. b. Determine the net present value of building the warehouse, assuming a construction cost of 25,000,000, an annual net cost savings of 2,500,000, and a desired rate of return of 14%. Use the present value tables provided in Appendix A. c. Interpret the results of parts (a) and (b).arrow_forwardMallette 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.arrow_forward
- Alfred Home Construction is considering the purchase of five dumpsters and the transport truck to store and transfer construction debris from building sites. The entire rig is estimated to have an initial cost of $142,500, a life of 8 years, a $8500 salvage value, an operating cost of $40 per day, and an annual maintenance cost of $8000. Alternatively, Alfred can obtain the same services from the city as needed at each construction site for an initial delivery cost of $125 per dumpster per site and a daily charge of $34 per day per dumpster. An estimated 19 construction sites will need debris storage throughout the average year. If the minimum attractive rate of return is 11% per year, how many days per year must the equipment be required to justify its purchase? The number of days per year the equipment must be required is determined to bearrow_forwardMetal Recycling and Salvage receives the opportunity to salvage scrap metal and other materials from an old industrial site. The current owners of the site will sign over the site to Enviro at no cost. Enviro intends to extract scrap metal at the site for 24 months and then will clean up the site, return the land to useable condition, and sell it to a developer. Projected costs associated with the project follow: Read the requirements2. Requirement 1. Assuming that Enviro expects to salvage 70,000tons of metal from the site, what is the total project life cycle cost? Total Life-Cycle Costs Variable costs: Metal extraction and processing Fixed costs: Metal extraction and processing Rent on temporary buildings Administration Clean-up Land restoration Selling land Total life-cycle cost Requirement 2. Suppose Enviro can sell the metal for $110 per ton and wants to earn a…arrow_forwardConsider the following project of Hand Clapper, Incorporated. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $12.2 million that will be depreciated straight-line to zero over the project's life. An initial investment in net working capital of $545,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $10.1 million in pretax revenues with $3.5 million in total pretax operating costs. The tax rate is 22 percent and the discount rate is 10 percent. The market value of the equipment over the life of the project is as follows: Year 1 AWN. 2 3 4 Market Value (millions) $9.8 7.9 4.3 1.1 a. Assuming the company operates this project for four years, what is the NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) b-1.…arrow_forward
- Consider the following project of Hand Clapper, Incorporated. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $13.8 million that will be depreciated straight-line to zero over the project's life. An initial investment in net working capital of $585,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $11.4 million in pretax revenues with $4.3 million in total pretax operating costs. The tax rate is 25 percent and the discount rate is 10 percent. The market value of the equipment over the life of the project is as follows: Market Value (millions) a. Year 1 $ 11.0 234 9.0 4.8 1.2 Assuming the company operates this project for four years, what is the NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) b-1. Compute…arrow_forwardConsider the following project of Hand Clapper, Incorporated. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $13.8 million that will be depreciated straight-line to zero over the project's life. An initial investment in net working capital of $585,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $11.4 million in pretax revenues with $4.3 million in total pretax operating costs. The tax rate is 25 percent and the discount rate is 10 percent. The market value of the equipment over the life of the project is as follows: Year Market Value (millions) $ 11.0 a. 1234 9.0 4.8 1.2 Assuming the company operates this project for four years, what is the NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) b-1. Compute…arrow_forwardConsider the following project for Hand Clapper, Inc. The company is considering a 4-year project to manufacture clap-command garage door openers. This project requires an initial investment of $16.7 million that will be depreciated straight-line to zero over the project’s life. An initial investment in net working capital of $1,070,000 is required tosupport spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $14.3 million in revenues with $5.8 million in operating costs. The tax rate is 22 percent and the discount rate is 14 percent. Themarket value of the equipment over the life of the project is as follows:d. Compute the project NPV assuming the project is abandoned after only threeyears.Year: Market Value ($ millions)1: $ 14.702: $11.703: $9.204: $1.95arrow_forward
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