The following is a comparison of the cost structure of a conventional manufacturing technology (CMT) system with that of a flexible manufacturing system (FMS) at one U.S. firm:

(a) The firm€™s marginal tax rate and MARR are 40% and 15%, respectively. Determine the incremental cash flow (FMS - CMT) based on the most likely estimates.

(b) Management feels confident about all input estimates for the CMT. However, the firm does not have any previous experience in operating an FMS. Therefore, many of the input estimates for that system, except the investment and salvage value, are subject to variation. Perform a sensitivity analysis on the project€™s data, varying the elements of the operating costs. Assume that each of these variables can deviate from its base€case expected value by ±10%, ± 20%, and ± 30 %.
(c) Prepare sensitivity diagrams and interpret the results.
(d) Suppose that probabilities of the variable material cost and the annual inventory cost for the FMS are estimated as follows:

Material Cost

Cost per Part               Probability

$1.0€¦€¦€¦€¦€¦€¦€¦€¦..€¦0.25

$1.10€¦€¦€¦€¦€¦€¦€¦€¦€¦0.30

$1.20€¦€¦€¦€¦€¦€¦€¦€¦€¦0.20

$1.30€¦€¦€¦€¦€¦€¦€¦€¦€¦0.20

$1.40€¦€¦€¦€¦€¦€¦€¦€¦€¦0.05

Inventory Cost

Annual Inventory Cost                       Probability

$25,000€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦0.10

$31,000€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦0.30

$50,000€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦0.20

$80,000€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦0.20

$100,000€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦€¦..0.20

What are the best and the worst cases of incremental PW?
(e) In part (d), assuming that the random variables of the cost per part and the annual inventory cost are statistically independent, find the mean and variance of the PW for the incremental cash flows.
(f) In parts (d) and (e), what is the probability that the FMS would be a more expensive investment option?

Transcribed Image Text:

Most Likely Estimates CMT FMS Number of part types 3,000 3,000 Number of pieces produced/year Variable labor cost/part 544,000 544,000 $1.30 $2.15 Variable material cost/part $1.53 $1.10 Total variable cost/part $3.68 $2.40 |Annual overhead costs $1.95M $3.15M Annual tooling costs $470,000 $300,000 Annual inventory costs $141,000 $31,500 Total annual fixed operating costs $2.28M $3.76M $3.5M $10M Investment $0.5M $1M Salvage value Service life 10 years 10 years 7 year Depreciation method (MACRS) 7 year