Chapter 11 - Master it!

Harper Industries is examining a new project to manufacture cell phones. The company has examined several alternatives for the manufacturing process. With Process I, the company would manufacture the cell phone entirely in-house. This would require the highest initial cost and fixed costs. Process II would involve subcontracting the manufacture of the electronics. While this would reduce the initial cost and fixed costs, it would result in higher variable costs. Finally, Process III would subcontract all production, with Harper Industries only completing the final assembly and testing. Below you are given the information for each of the options available to the company.

Process I

Process II

Process III

Initial cost:

$ 75,000,000

$ 55,000,000

$ 36,000,000

Life (years):

7

Units:

450,000

Price per unit:

$ 345

VC per unit:

$ 85

$ 137

$ 182

Fixed costs:

$ 81,000,000

$ 63,000,000

$ 48,000,000

Required return:

13%

Tax rate:

38%

a.

Calculate the NPV for each of the 3 manufacturing processes available to the company.

b.

What are the accounting break-even, cash break-even, and financial break-even points for each manufacturing process?

c.

What is the DOL for each manufacturing process? Graph the DOL for each manufacturing process on the same graph for different unit sales.

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	Master it! Solution
	First, you will need to replicate the information about each manufacturing process below. You will need to create a table for part of this assignment and Excel has a bug that will not allow you to create a table with a variable in another worksheet.
		Process I	Process II	Process III
	Initial cost:
	Life (years):
	Units:
	Price per unit:
	VC per unit:
	Fixed costs:
	Required return:
	Tax rate:
a.		Pro Forma Income Statements
		Process I	Process II	Process III
	Sales
	Variable costs
	Fixed costs
	Depreciation
	EBIT
	Taxes (0%)
	Net income
	OCF
	NPV
b.			Process I	Process II	Process III
	Accounting break-even
	Cash break-even
	Financial break-even
c.		Process I				Process II
	Unit sales	OCF	DOL		Unit sales	OCF	DOL
	350,000
	370,000
	390,000
	410,000
	430,000
	450,000
	470,000
	490,000
	510,000
	530,000
	550,000
		Process III
	Unit sales	OCF	DOL