You are the assistant to the vise president for manufacturing. The staff at one

Question

You are the assistant to the vise president for manufacturing. The staff at one of the plants has recommended approval for the a new production line. The VP believes the numbers presented are to optimistic and has added a set of adjustments to the original estimate. Original Adjustment First Cost Units/year Net Unit Revenue Life, in years Interest Rate $70,000 1,200 $25 +10% -20% 15% .3 None 12% Analyze the project as originally submitted. Reanalyze the project, asking "What if the VP's adjustments are correct?"

Explanation / Answer

(1) Per original estimates,

Annual revenue = 1,200 x $25 = $30,000

Present worth (PW) ($) = - 70,000 + 30,000 x P/A(12%, 8) = - 70,000 + 30,000 x 4.9676 = - 70,000 + 149,028

= 79,028

Since PW is positive, this project is acceptable.

(2) After adjustment

First cost = $70,000 x 1.1 = $77,000

Units per year = 1,200 x 80% = 960

Net unit revenue = $25 x 85% = $21.25

Annual revenue = $21.25 x 960 = $20,400

Useful life = 8 - 3 = 5

Therefore,

PW ($) = - 77,000 + 20,400 x P/A(12%, 5) = - 77,000 + 20,400 x 3.6048 = - 77,000 + 73,537.92 = - 3,462.08

Since PW is negative, adjusted project is not acceptable.

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