The CEO of Orange, Inc. is evaluating a proposal for outsourcing all their inter

Question

The CEO of Orange, Inc. is evaluating a proposal for outsourcing all their internal part production and focusing internal operations only on assembly of the parts.    The cost to convert to outsourcing ,forecast at $350,000, is not depreciable and will be expensed (paid for) in year 1, and should be listed separately from S.G.&A. The proposal is forecasted to reduce the unit cost of the parts by 15% in year 1 and then the cost will be constant at the reduced level in the future. The assembly cost per unit will not change; just the quantity. The additional purchasing effort is expected to increase S.G.& A. expense by 8% in year 1 and hold constant at the the new level in the future. This sales price of their single product will be reduced by 5% in year 1 and then held constant at this level in the future. The price decrease is forecasted to increase sales quantities as shown below. Without the proposal the sales price, costs to produce, S.G.& A., and sales are all expected to stay the same as present.   Construct the Income statement part of a financial analysis that could be used to evalaute the proposal. The time horizon for this proposal is 5 years. Show all subtotals in the income statement. Year 1 2 3 4 5 Sales Quantity- with proposal 126,000 132,300 138,915 145,861 153,154 Sales Quantity - without proposal 120,000 120,000 120,000 120,000 120,000 Present one-time change Proposed Sales Price per unit $18.99 5% less Machined parts cost per unit $4.40 15% less Assembly cost per unit $5.60 0% no change S.G. & A per year $150,000 8% increase Cost of proposal $350,000 Separate from S.G. & A. Proposal life span 5 years Income tax 14% annually MARR 10% annually The CEO of Orange, Inc. is evaluating a proposal for outsourcing all their internal part production and focusing internal operations only on assembly of the parts.    The cost to convert to outsourcing ,forecast at $350,000, is not depreciable and will be expensed (paid for) in year 1, and should be listed separately from S.G.&A. The proposal is forecasted to reduce the unit cost of the parts by 15% in year 1 and then the cost will be constant at the reduced level in the future. The assembly cost per unit will not change; just the quantity. The additional purchasing effort is expected to increase S.G.& A. expense by 8% in year 1 and hold constant at the the new level in the future. This sales price of their single product will be reduced by 5% in year 1 and then held constant at this level in the future. The price decrease is forecasted to increase sales quantities as shown below. Without the proposal the sales price, costs to produce, S.G.& A., and sales are all expected to stay the same as present.   Construct the Income statement part of a financial analysis that could be used to evalaute the proposal. The time horizon for this proposal is 5 years. Show all subtotals in the income statement. Year 1 2 3 4 5 Sales Quantity- with proposal 126,000 132,300 138,915 145,861 153,154 Sales Quantity - without proposal 120,000 120,000 120,000 120,000 120,000 Present one-time change Proposed Sales Price per unit $18.99 5% less Machined parts cost per unit $4.40 15% less Assembly cost per unit $5.60 0% no change S.G. & A per year $150,000 8% increase Cost of proposal $350,000 Separate from S.G. & A. Proposal life span 5 years Income tax 14% annually MARR 10% annually

Explanation / Answer

The proposal should be accepted as the net present value of income is greater than with proposal

With Proposal Year 1 2 3 4 5 Sales Quantity- with proposal 126,000 132,300 138,915 145,861 153,154 Sales Price $                 18.04 $                18.04 $                18.04 $                18.04 $                18.04 Revenue $ 2,273,103.00 $ 2,386,758.15 $ 2,506,096.06 $ 2,631,405.37 $ 2,762,974.74 Variable cost per unit Machine cost per unit 3.74 3.74 3.74 3.74 3.74 Assembly cost per unit 5.6 5.6 5.6 5.6 5.6 Total variable cost per unit 9.34 9.34 9.34 9.34 9.34 Total variable cost $ 1,176,840.00 $ 1,235,682.00 $ 1,297,466.10 $ 1,362,341.74 $ 1,430,458.36 SGA cost 512000 162000 162000 162000 162000 EBT $      584,263.00 $      989,076.15 $ 1,046,629.96 $ 1,107,063.63 $ 1,170,516.38 Taxes $        81,796.82 $      138,470.66 $      146,528.19 $      154,988.91 $      163,872.29 Net income $      502,466.18 $      850,605.49 $      900,101.76 $      952,074.72 $ 1,006,644.08 Net present value of cash flows $3,111,353.58 Without Proposal Year 1 2 3 4 5 Sales Quantity- with proposal 120,000 120,000 120,000 120,000 120,000 Sales Price $                 18.99 $                18.99 $                18.99 $                18.99 $                18.99 Revenue $ 2,278,800.00 $ 2,278,800.00 $ 2,278,800.00 $ 2,278,800.00 $ 2,278,800.00 Variable cost per unit Machine cost per unit 4.4 3.74 3.74 3.74 3.74 Assembly cost per unit 5.6 5.6 5.6 5.6 5.6 Total variable cost per unit 10 9.34 9.34 9.34 9.34 Total variable cost $ 1,200,000.00 $ 1,120,800.00 $ 1,120,800.00 $ 1,120,800.00 $ 1,120,800.00 SGA cost 500000 500000 500000 500000 500000 EBT $      578,800.00 $      658,000.00 $      658,000.00 $      658,000.00 $      658,000.00 Taxes $        81,032.00 $        92,120.00 $        92,120.00 $        92,120.00 $        92,120.00 Net income $      497,768.00 $      565,880.00 $      565,880.00 $      565,880.00 $      565,880.00 Net present value of cash flows $2,083,210.42

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