Your company, The World's Greatest Coffee Cup company is doing great. Sales have been extremely strong and you cannot manufacture them fast enough. You identified 3 alternatives which you are considering. The company's cost of capital is 10%.

Alternative 1:

Invest in a new machine to increase your manufacturing volume. The machine would cost S1.SM and have a useful life of 10 years and can produce 10,000 mugs per day. You would need to invest $250,000 in startup capital. This would allow you to generate $150,000 in cashflows for the next 10 years. The machine would require major repairs in years 8 costing $285,000.

Alternative 2:

Production is outsourced. This would require closing the current facility and doing only sales and warehousing in Canada meaning 15 people would lose their job. The current contract being considered is for 10 years. It would require the company to invest $500,000 in working capital (mainly inventory) due to the longer lead times. The contract would allow them to generate $125,000 more cash flows for the next 10 years. The current equipment could be sold for $75,000. 

Alternative 3:

The selling price is increased to $50 per mug which will slow down demand to manufacturing capacity but generate $50,000 more in cash flows each year for the next 10 years.

Required:

1) Using the payback period and the net present value model, which alternative would you advise and why.

2) What other factors might be considered in making this decision

Answer rating: 100% (QA)

1 Using the payback period and the net present value NPV model which alternative would you advise and why Payback Period Analysis Alternative 1 Initia... View the full answer