This is a problem with mutually exclusive projects. You should evaluate each pro

Question

This is a problem with mutually exclusive projects. You should evaluate each project separately. Questions 1 & 2 ask for cash flows only. 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.

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $205 with a resulting contribution margin of $72.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $41,000 a year to inspect the CD players. An average of 1,900 units turn out to be defective - 1,330 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 510 CD players a year for the next four years. In other words, it will fall by 510 units in the first year, 1,020 units in the second year, etc..

The proposed quality control system involves the purchase of an x-ray machine for $280,000. 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 360 per year. 295 of these defective units would be detected and repaired at a cost of $47 per unit. Customers who still received defective players would be given a refund equal to one-and-a-fourth times the purchase price.

Questions 1 & 2
1. What is the Year 3 cash flow if Brisbane keeps using its current system?

2. What is the Year 3 cash flow if Brisbane replaces its current system?

Questions 3 & 4
3. Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system?

4. Assuming a discount rate of 8%, what is the net present value if Brisbane replaces its current system?

Explanation / Answer

Replace syaytem 2 Current Syatem Ist year Iind year IIIrd year 4 th year Sales units (Current sales units 5100)              5,100              5,100           5,100                5,100 Sales price per unit                 205                  205              205                   205 Contribution margin per unit                   72                    72                72                     72 Total Contribution margin         367,200          367,200      367,200           367,200 Salvage value of machine             22,000 Less: yearly Inspection Expenses (41000+25000)           66,000            66,000        66,000             66,000 Yearly defective repair cost (47*295)           13,865            13,865        13,865             13,865 Amount refund per year (360-295)*205/4              3,331              3,331           3,331                3,331 Yearly cash Flow         284,004          284,004      284,004           306,004 So third year cash flow is 284004 3 NPV for current system Current Syatem Ist year Iind year IIIrd year 4 th year Sales units (Current sales units 5100)              4,590              4,080           3,570                3,060 Sales price per unit                 205                  205              205                   205 Contribution margin per unit                   72                    72                72                     72 Total Contribution margin         330,480          293,760      257,040           220,320 Less: yearly Inspection Expenses           41,000            41,000        41,000             41,000 Yearly defective repair cost (75*1330)           99,750            99,750        99,750             99,750 Amount refund per year (1900-1330)*205         116,850          116,850      116,850           116,850 Yearly cash Flow           72,880            36,160             -560            -37,280 Total NPV of yearly cash flow           67,481            31,001             -445            -27,402         70,636 NPV for current syaytem is $ 70636 Replace syaytem 4 Current Syatem Year 0 Ist year Iind year IIIrd year 4 th year Sales units (Current sales units 5100)              5,100           5,100                5,100           5,100 Sales price per unit                  205              205                   205              205 Contribution margin per unit                    72                72                     72                 72 Total Contribution margin          367,200      367,200           367,200      367,200 Salvage value of machine         22,000 Less: X-ray machine Cost         280,000 Training Cost         780,000 yearly Inspection Expenses (41000+25000)            66,000        66,000             66,000         66,000 Yearly defective repair cost (47*295)            13,865        13,865             13,865         13,865 Amount refund per year (360-295)*205/4              3,331           3,331                3,331           3,331 Yearly cash Flow      1,060,000          284,004      284,004           284,004      306,004 NPV of yearly cash flow    -1,060,000          262,966      243,487           225,451      224,922 NPV for replace syaytem is        -103,173

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.