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. 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
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The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $194 with a resulting contribution margin of $70.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $38,500 a year to inspect the CD players. An average of 2,000 units turn out to be defective - 1,400 of them are detected in the inspection process and are repaired for $80. 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 520 CD players a year for the next five years. In other words, it will fall by 520 units in the first year, 1,040 units in the second year, etc..

The proposed quality control system involves the purchase of an x-ray machine for $290,000. The machine would last for five years and would have salvage value at that time of $21,000. Brisbane would also spend $780,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $21,000. This new control system would reduce the number of defective units to 400 per year. 350 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-half times the purchase price.

Questions 1 & 2 [0 points; unlimited tries]
1. What is the Year 2 cash flow if Brisbane keeps using its current system? $-339,700  

2. What is the Year 2 cash flow if Brisbane replaces its current system? $-90,150  

Questions 3 & 4 [5 points each; 5 tries each]
3. Assuming a discount rate of 6%, what is the net present value if Brisbane keeps using its current system?  

4. Assuming a discount rate of 6%, what is the net present value if Brisbane replaces its current system?

You are correct.
Your receipt no. is 150-670 Previous Tries

Explanation / Answer

Part 3)

To calculate NPV, we need to determine the cash flow/total cost if Brisbane keeps using its current system. The cash flows are calculated with the use of following table

Current System:

The formula for calculating NPV is given below:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 2/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3 + Cash Flow Year 4/(1+Discount Rate)^4 + Cash Flow Year 5/(1+Discount Rate)^5

Now, we can calculate NPV with the use of cash flows calculated in the above table.

NPV = -303,300/(1+6%)^1 - 339,700/(1+6%)^2 - 376,100/(1+6%)^3 - 412,500/(1+6%)^4 - 448,900/(1+6%)^5 = -$1,566,427.51 or - $1,566,428

________

Part 4)

The cash flows if company replaces the system are as follows:

Cash Flow Year 0 = -290,000 (Cost of System) - 780,000 (Cost of Training) = - $1,070,000

Cash Flow Year 1 to 4 (as provided above in question) = -$90,150 (cash flow remains constant for all the years)

Cash Flow Year 5 = -90,150 + 21,000 (salvage value) = -$68,150

Using these values in the above formula for NPV, we get,

NPV = -1,070,000 - 90,150/(1+6%)^1 - 90,150/(1+6%)^2 - 90,150/(1+6%)^3 - 90,150/(1+6%)^4 - 68,150/(1+6%)^5 = -$1,433,305

Year Cost of Inspection Cost to Repair Defects (1,400*80) Refund (600*194) Loss of Contribution Total Cost 1 38,500.00 112,000.00 116,400.00 36,400.00 (520*70) 303,300.00 2 38,500.00 112,000.00 116,400.00 72,800.00 (520*2*70) 339,700.00 3 38,500.00 112,000.00 116,400.00 109,200.00 (520*3*70) 376,100.00 4 38,500.00 112,000.00 116,400.00 145,600.00 (520*4*70) 412,500.00 5 38,500.00 112,000.00 116,400.00 182,000.00 (520*5*50) 448,900.00

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