NPV, Make or Buy, MACRS, Basic Analysis Jonfran Company manufactures three diffe
ID: 2404742 • Letter: N
Question
NPV, Make or Buy, MACRS, Basic Analysis
Jonfran Company manufactures three different models of paper shredders including the waste container, which serves as the base. While the shredder heads are different for all three models, the waste container is the same. The number of waste containers that Jonfran will need during the following years is estimated as follows:
The equipment used to manufacture the waste container must be replaced because it is broken and cannot be repaired. The new equipment would have a purchase price of $945,000 with terms of 2/10, n/30; the company’s policy is to take all purchase discounts. The freight on the equipment would be $11,000, and installation costs would total $22,900. The equipment would be purchased in December 20x4 and placed into service on January 1, 20x5. It would have a five-year economic life and would be treated as three-year property under MACRS. This equipment is expected to have a salvage value of $12,000 at the end of its economic life in 20x9. The new equipment would be more efficient than the old equipment, resulting in a 25 percent reduction in both direct materials and variable overhead. The savings in direct materials would result in an additional one-time decrease in working capital requirements of $2,500, resulting from a reduction in direct material inventories. This working capital reduction would be recognized at the time of equipment acquisition.
The old equipment is fully depreciated and is not included in the fixed overhead. The old equipment from the plant can be sold for a salvage amount of $1,500. Rather than replace the equipment, one of Jonfran’s production managers has suggested that the waste containers be purchased. One supplier has quoted a price of $27 per container. This price is $8 less than Jonfran’s current manufacturing cost, which is as follows:
Jonfran uses a plantwide fixed overhead rate in its operations. If the waste containers are purchased outside, the salary and benefits of one supervisor, included in fixed overhead at $45,000, would be eliminated. There would be no other changes in the other cash and noncash items included in fixed overhead except depreciation on the new equipment.
Jonfran is subject to a 40 percent tax rate. Management assumes that all cash flows occur at the end of the year and uses a 12 percent after-tax discount rate.
You must use the Exhibit 19B.1 and Exhibit 19B.2 present value tables and Exhibit 19.5 to solve the following problems.
Required:
1. Prepare a schedule of cash flows for the make alternative. Enter cash outflows as negative amounts and cash inflows as positive amounts. Round your answers to the nearest dollar when rounding is required.
Calculate the NPV of the make alternative. Round intermediate calculations and your final answer to the nearest dollar. If the NPV is negative, enter your answer as a negative value.
$_____________
2. Prepare a schedule of cash flows for the buy alternative. Enter cash outflows as negative amounts and cash inflows as positive amounts.
Calculate the NPV of the buy alternative. Round intermediate calculations and your final answer to the nearest dollar. If the NPV is negative, enter your answer as a negative value.
$__________
Explanation / Answer
(1) Preparing a schedule of cash flows for the make alternative: Jonfran Company Schedule of Cash Flows Year Item CF 2014 Equipment ($945,000) Discount $18,900 Freight ($11,000) Installation ($22,900) Salvage - Old (0.6 * $1,500) $900 Working Capital Reduction $2,500 Total ($956,600) 2015 Operating expensesa ($627,000) Depreciation tax shieldb $127,987 Total ($499,013) 2016 Operating expensesa ($627,000) Depreciation tax shieldb $170,688 Total ($456,312) 2017 Operating expensesa ($651,000) Depreciation tax shieldb $56,870 Total ($594,130) 2018 Operating expensesa ($687,000) Depreciation tax shieldb $28,454 Total ($658,546) 2019 Operating expensesa ($687,000) Salvage - new (0.6 * $12,000) $7,200 Total ($679,800) a) Unit Cost Direct Materials $10 * 0.75 $7.50 Direct Labor $8 * 1.00 $8.00 Variable Overhead $6 * 0.75 $4.50 Total $20.00 b) Depreciation shield: Year Value Rate Allowance Tax Rate Shield 2015 $960,000 0.3333 $319,968 0.4 $127,987 2016 $960,000 0.4445 $426,720 0.4 $170,688 2017 $960,000 0.1481 $142,176 0.4 $56,870 2018 $960,000 0.0741 $71,136 0.4 $28,454 Year 2015 Variable Costs $20 * 50,000 = $1,000,000 * 0.6 = $600,000 Fixed Costs $45,000 * 0.6 = $27,000 2016 Variable Costs $20 * 50,000 = $1,000,000 * 0.6 = $600,000 Fixed Costs $45,000 * 0.6 = $27,000 2017 Variable Costs $20 * 52,000 = $1,040,000 * 0.6 = $624,000 Fixed Costs $45,000 * 0.6 = $27,000 2018 Variable Costs $20 * 55,000 = $1,100,000 * 0.6 = $660,000 Fixed Costs $45,000 * 0.6 = $27,000 2019 Variable Costs $20 * 55,000 = $1,100,000 * 0.6 = $660,000 Fixed Costs $45,000 * 0.6 = $27,000 NPV: Year CF df Present Value 2014 ($956,600) 1 ($956,600) 2015 ($499,013) 0.893 -4,45,619 2016 ($456,312) 0.797 -3,63,681 2017 ($594,130) 0.712 -4,23,021 2018 ($658,546) 0.636 -4,18,835 2019 ($679,800) 0.567 -3,85,447 NPV ($2,993,203) 2) Preparing a schedule of cash flows for the buy alternative: Jonfran Company Schedule of Cash Flows Year Item CF 2014 Salvage - Old (0.6 * $1,500) = $900 2015 Purchase Cost $27 * 50,000 * 0.6 = ($810,000) 2016 Purchase Cost $27 * 50,000 * 0.6 = ($810,000) 2017 Purchase Cost $27 * 52,000 * 0.6 = ($842,400) 2018 Purchase Cost $27 * 55,000 * 0.6 = ($891,000) 2019 Purchase Cost $27 * 55,000 * 0.6 = ($891,000) NPV: Year CF df Present Value 2014 $900 1 $900 2015 ($810,000) 0.893 -7,23,330 2016 ($810,000) 0.797 -6,45,570 2017 ($842,400) 0.712 -5,99,789 2018 ($891,000) 0.636 -5,66,676 2019 ($891,000) 0.567 -5,05,197 NPV ($3,039,662) Therefore, it is better to Produce the Products by internal Production, because it has a lower cost than purchasing
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