6-10. Cost of Capital and CVP Analysis of Mutually Exclusive Projects (R. Manes)

Question

6-10. Cost of Capital and CVP Analysis of Mutually Exclusive Projects (R. Manes) Machine A costs $8.000 has a 4-year life and no salvage value. It yields output which sells at $25 per unit and costs $15 per unit in variable costs of production so that its contribution margin is $10. Machine B costs S12.000. also has a 4-year life and no salvage value. Its output is identical to that of Machine A. also sells at $25 per unit but has a contribution margin of S13 per unit. Required 1. .Ignoring out-of-pocket fixed costs per period, taxes. inflation and growth and making no allowance for the cost of capital, what is the cross-over point with respect to acquisition of Machine A or B: that is obtain the volume at which one machine becomes preferable to the other? What is this point for a 12 percent discount rate? Which machine should the company acquire if it contemplates per period sales of 375 units? 2. 3. 6-11. Review of Multi-Period Breakeven Analysis and Extensions for Taxes, Depreciation, and Inflation (R. Manes A company is contemplating the purchase of fully automatic machinery for producing widgets. The price of a widget is S10, the variable cost with the new machinery is $1.25 per widget, and the fixed annual cash operating cash outlays are S 16,000. The machinery costs $15.000 and has a useful life of 4 years, independent of production volume. The firm has a cost of capita! of 10 percent Required 1. Compute the annual breakeven volume, ignoring capital costs 2. Compute the annual breakeven volume including the cost of the machinery and the 10 percent cost of capital. 3. Compute the annual breakeven volume, including capital costs, relative to the current alternative of producing widgets manually at a cost of $4 per widget and with annuail fixed cash outlays of $12.000 per year 4. Repeat parts (). (), and 8) when the firm pays income taxes at a 40 ercent rate, and uses straight-line depreciation for the machinery. Assume that the after-tax cost of capital is also 10 percent. (More complicated version) Ignore the option of producing widgets man- ually. What is the annual breakeven volume if there is a 5 percent annual inflation (affecting both prices and costs); the company uses sum-of-the- 5. s digits depreciation, and the company now requires 15 percent after year tax cost of capital (a higher discount rate to compensate for the ex inflation during the next four years)? pected Tinelated interastrate -i,est of Capiel siy infiution rute ha-f

Explanation / Answer

Machine A Machine B Cost($) 8000 12000 Useful Life(yrs) 4 4 Contribution/unit ($) 10 13 Salvage Value($) 0 0 Break even 800 923 1. Cross over point =(12000-8000)/(13-10) 1333.3333 i.e. 1333.333/4 = 333.333units p.a. Units produced p.a. Preferred Machine

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