Supreme Chips is a manufacturer of prototype chips based in Dublin, Ireland. Nex
ID: 2574701 • Letter: S
Question
Supreme Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2018,Supreme Chips expects to deliver 575 prototype chips at an average price of $90,000. Supreme Chips' marketing vice president forecasts growth of 55 prototype chips per year through 2024.
That is, demand will be 575 in 2018,630 in 2019,685 in 2020, and so on.
The plant cannot produce more than 545 prototype chips annually. To meet future demand,Supreme Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $4,700,000. if the plant is replaced. If the plant is modernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative. The following data on the two options are available:
Modernize
Replace
Initial investment in 2018
$34,800,000
$66,100,000
Terminal disposal value in 2024
$6,600,000
$16,800,000
Useful life
7 years
7 years
Total annual cash operating cost per prototype chip
$74,500
$65,000
Supreme Chips uses straight-line depreciation, assuming zero terminal disposal value. For simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of 2018, and all transactions thereafter occur on the last day of the year.Supreme Chips' required rate of return is 6%.There is no difference between the modernize and replace alternatives in terms of required working capital. Supreme Chips has a special waiver on income taxes until 2024.
Requirement 1. Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2018-2024 period.
First, determine the cash inflows and outflows of the modernize alternative over the 2018 to 2024 period. (Use a minus sign or parentheses for a cash outflows. Leave unused cells blank.)
Units
Net cash
Initial
Proceeds from
Year
sold
contributions
investments
sale of equipment
Jan 1, 2018
$(34,800,000)
Dec 31, 2018
575
$8,912,500
Dec 31, 2019
630
9,765,000
Dec 31, 2020
685
10,617,500
Dec 31, 2021
740
11,470,000
Dec 31, 2022
795
12,322,500
Dec 31, 2023
850
13,175,000
Dec 31, 2024
905
14,027,500
$6,600,000
Next, determine the cash inflows and outflows of the replace alternative over the 2018 to 2024 period. (Use a minus sign or parentheses for a cash outflows. Leave unused cells blank.)
Units
Net cash
Initial
Proceeds from
Year
sold
contributions
investments
sale of equipment
Jan 1, 2018
$(66,100,000)
$4,700,000
Dec 31, 2018
575
$14,375,000
Dec 31, 2019
630
15,750,000
Dec 31, 2020
685
17,125,000
Dec 31, 2021
740
18,500,000
Dec 31, 2022
795
19,875,000
Dec 31, 2023
850
21,250,000
Dec 31, 2024
905
22,625,000
$16,800,000
Requirement 2. Calculate payback period for the modernize and replace alternatives. (Round your answers to two decimal places.)
The payback period for the investment assuming the modernize alternative is ____ years.
3.
Calculate net present value of the modernize and replace alternatives
Modernize
Replace
Initial investment in 2018
$34,800,000
$66,100,000
Terminal disposal value in 2024
$6,600,000
$16,800,000
Useful life
7 years
7 years
Total annual cash operating cost per prototype chip
$74,500
$65,000
Explanation / Answer
Requirement 3: Net Present Values
Requirement 2 Modernize option Year Initial Net annual Cumulative Investment Cash flows cash flows. -34800000 -34800000 1 8912500 -25887500 2 9765000 -16122500 3 10617500 -5505000 4 11470000 5965000 5 12322500 18287500 6 13175000 31462500 7 20627500 52090000 As can be sen fromt he above the inestment is being recovered during the fourth (cumulative cash flow is turning positive in the fourth year) Therefore payback period = 3+(550500/11470000) = 3.05 years Expansion option Year Initial Net annual Cumulative Investment Cash flows cash flows. -66100000 4700000 -61400000 1 14375000 -47025000 2 15750000 -31275000 3 17125000 -14150000 4 18500000 4350000 5 19875000 24225000 6 21250000 45475000 7 39425000 84900000 As can be sen fromt he above the inestment is being recovered during the fourth (cumulative cash flow is turning positive in the fourth year) Therefore payback period = 3+(14150000/18500000) = 3.08 yearsRelated Questions
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