CAPITAL BUDGETING This is a problem with mutually exclusive projects. You should
ID: 2459551 • Letter: C
Question
CAPITAL BUDGETING
This is a problem with mutually exclusive projects. You should evaluate each project separately. Questions 1 & 2 ask for cash flows only. They are not worth any points, and you are allowed unlimited tries. Their purpose is to make sure you've figured out the correct cash flows before you move on to net present values. Questions 3 & 4 require that you use the correct cash flows from 1 and 2 to determine the net present values of the two alternatives. They are worth five points each, and you are allowed five tries for each. You should use the present value tables in the Coursepack The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $181 with a resulting contribution margin of $75. Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends 538,000 a year to inspect the CD players. An average of 1,800 units turn out to be defective - 1,440 of them are detected in the inspection process and are repaired for $75. If a defective CD player is not identified in the inspection process, the customer who receives it is given a full refund of the purchase price. Competitors are expected to improve their quality control systems in the future, so if Brisbane does not improve its system, sales volume is expected to fall by 480 CD players a year for the next four years. In other words, it will fall by 480 units in the first year, 960 units in the second year, etc.. The proposed quality control system involves the purchase of an x-ray machine for 5290,000. The machine would last for four years and would have salvage value at that time of $22,000. Brisbane would also spend $780,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $25,000. This new control system would reduce the number of defective units to 400 per year. 345 of these defective units would be detected and repaired at a cost of $46 per unit. Customers who still received defective players would be given a refund equal to one-and-a-fourth times the purchase price. What is the Year 3 cash flow if Brisbane keeps using its current system? What is the Year 3 cash flow if Brisbane replaces its current system? Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system? Assuming a discount rate of 8%, what is the net present value if Brisbane replaces its current system?Explanation / Answer
Answer
Answer 1
The Year 3 cash out flow is $ 292160 if Brisbane keeps using its current system (See below table Answer 3)
Answer 2
The Year 3 cash out flow is 87188.75 if Brisbane replaces its current system.(See below table Answer 4)
Answer 3
If Brisbane keeps using its current system
Figures in $
Year
Inspection cost
Contribution lost on sales fall
Repair cost of defective units
Refund cost on defective units
Cash outflow
Disc Rate : 8%
Present value
A
B
C
D
E
F
Sales fall* Contribution
1440*75
(1800-1440)*(181-75)
A+B+C+D
E*F
1
38000
36000
108000
38160
220160
0.93
203851.85
2
38000
72000
108000
38160
256160
0.86
219615.91
3
38000
108000
108000
38160
292160
0.79
231926.03
4
38000
144000
108000
38160
328160
0.74
241207.40
Net present cash outflow
896601.19
Answer 4
If Brisbane replaces its current system
Figures in $
Year
Inspection cost
Training cost
Purchase of X-ray machine
Repair cost of Defective units
Refund cost of defective units
Cash outflow
Disc Rate : 8%
Present value
A
B
C
D
E
F
G
38000+25000
345*46
(400-345)*(181-75)+(400-345)*(181/4)
A+B+C+D+E
F*G
0
780000
290000
1070000
1.00
1070000.00
1
63000
15870
8318.75
87188.75
0.93
80730.32
2
63000
15870
8318.75
87188.75
0.86
74750.30
3
63000
15870
8318.75
87188.75
0.79
69213.24
4
63000
-22000
15870
8318.75
65188.75
0.74
47915.68
Net present cash outflow
1342609.54
Figures in $
Year
Inspection cost
Contribution lost on sales fall
Repair cost of defective units
Refund cost on defective units
Cash outflow
Disc Rate : 8%
Present value
A
B
C
D
E
F
Sales fall* Contribution
1440*75
(1800-1440)*(181-75)
A+B+C+D
E*F
1
38000
36000
108000
38160
220160
0.93
203851.85
2
38000
72000
108000
38160
256160
0.86
219615.91
3
38000
108000
108000
38160
292160
0.79
231926.03
4
38000
144000
108000
38160
328160
0.74
241207.40
Net present cash outflow
896601.19
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