AccuSpeaker manufactures stand-alone speakers including the enclosure, which are then sold under the labels of AccuSpeaker at

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Question:

AccuSpeaker manufactures stand-alone speakers including the enclosure, which are then sold under the labels of AccuSpeaker at major retailers. The speakers are also sold without enclosures to other manufacturers. Your new job is as staff assistant to Henry Higgins, the CEO. One of your first tasks is to evaluate the proposed capital budgets of the manufacturing and marketing department heads. These proposals represent the second step in the annual budgeting exercise, which begins with the CEO and the department heads identifying the projects that might be undertaken. After each of the four department heads ranks the alternatives, the CEO evaluates each proposed budget. He then prepares a budget that is the basis for further discussion, modification, and finally adoption. Henry Higgins is a firm believer in training and testing. Evaluating all four proposals would probably be overwhelming, so he only gave you the memos from two departments. He has also decided not to guide your thinking by letting you examine last year’s proposals and summation. By forcing you to compare two budgets, the CEO can observe your skill at ferreting out the truth from alternative perspectives. By examining your methodology, he can check for other theoretical approaches that may differ from the firm’s historical techniques. Henry has identified $1.5 million as next year’s capital budget, although transfers between the capital and operating budgets gives some flexibility. He has indicated that the firm is borrowing money with long-term loans at 9%, that last year’s returns on sales was 6%, and that contribution to profit and overhead is about 65% for most products.

We discussed numerous projects at our recent meeting, but I believe that we reached a consensus that the following three (with some mutually exclusive alternatives) were the ones worth further consideration. We also agreed to follow the same process as last year. The next step is to prioritize the projects with their preferred alternatives. Please have your memos on your proposed capital budget to me by October 22, so that we can refine these before the Board of Directors’ meeting in early November.

Project 1(Installation of CAD/CAM System): The computer science department has been using computers for analysis of proposed designs for years, but we have not yet attempted to integrate this with the drafting or manufacturing processes. They have suggested that we purchase an integrated system from the ADAM Corp. (Aiding Design And Manufacturing). The proposal can be undertaken immediately, or we can do a part of it now and decide later on the rest. We believe that ADAM will cut the price for each module by 10% for each one we buy at the same time. Thus if we buy option 3 immediately, then the prices for the analytic, the drafting, and the control modules will all be cut by 20% (both hardware and software). If we wait to purchase the more advanced modules, some decline in hardware costs is likely. They charge a 15% annual fee for maintenance and updates.

Option 1: Replace our current computer system with ADAM's analytic module. This would provide the foundation for purchase of other modules later, and it would allow us to better judge ADAM before we commit substantial sums. This provides little in new capabilities, but would require about 6 man-months in training for users (engineers) at $5000 per month including benefits. The cost for hardware is $50,000 with a 10-year physical life, while the software will cost another $50,000.

For option 1 calculate IRR (Use 15% MARR for calculating IRR) and Payback period.