Woolrich Companys market research division has projected a substantial increase in demand over the next several years for one of the companys products. To meet this demand, the company will need to produce units as follows:ProductionYear in Units1 . . . . . . . . . . 20,0002 . . . . . . . . . . 30,0003
Year in Units
1 . . . . . . . . . . 20,000
2 . . . . . . . . . . 30,000
3 . . . . . . . . . . 40,000
410. . . . . . . .45,000
At present, the company is using a single model 2600 machine to manufacture this product. To increase its productive capacity, the company is considering two alternatives:
Alternative 1. The company could purchase another model 2600 machine that would operate along with the one it now owns. The following information is available on this alternative:
a. The model 2600 machine now in use was purchased for $165,000 four years ago. Its present book value is $99,000, and its present market value is $90,000.
b. A new model 2600 machine costs $180,000 now. The old model 2600 machine will have to be replaced in six years at a cost of $200,000. The replacement machine will have a market value of about $100,000 when it is four years old.
c. The variable cost required to produce one unit of product using the model 2600 machine is given under the general information below.
d. Repairs and maintenance costs each year on a single model 2600 machine total $3,000.
Alternative 2. The company could purchase a model 5200 machine and use the old model 2600 machine as standby equipment. The model 5200 machine is a high-speed unit with double the capacity of the model 2600 machine. The following information is available on this alternative:
a. The cost of a new model 5200 machine is $250,000.
b. The variable cost required to produce one unit of product using the model 5200 machine is given under the general information below.
c. The model 5200 machine is more costly to maintain than the model 2600 machine. Repairs and maintenance on a model 5200 machine and on a model 2600 machine used as standby would total $4,600 per year. The following general information is available on the two alternatives:
a. Both the model 2600 machine and the model 5200 machine have a 10-year life from the time they are first used in production. The scrap value of both machines is negligible and can be ignored. Straight-line depreciation is used by the company.
b. The two machine models are not equally efficient. Comparative variable costs per unit of product are as follows:
c. No other factory costs would change as a result of the decision between the two machines.
d. Woolrich Company uses an 18% discount rate.
(Ignore income taxes.)
1. Which alternative should the company choose? Use the net present value approach. (Round to the nearest whole dollar.)
2. Suppose that the cost of direct materials increases by 50%. Would this make the model 5200 machine more or less desirable? Explain. No computations are needed.
3. Suppose that the cost of direct labor increases by 25%. Would this make the model 5200 machine more or less desirable? Explain. No computations areneeded.
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at...