You are the owner of a company that produces Zumba toning sticks, and business i

Question

You are the owner of a company that produces Zumba toning sticks, and business is really on the rise. The Zumba machine you currently use can produce 10,000 toning sticks per week (5,000 pairs) on a single 8 hour production shift. You sell a pair of sticks at wholesale for $8.56, and your production cost (including materials and direct labor) per pair is $4.00. The problem is you are currently selling every stick you produce, and are falling behind on orders. You are concerned that a competitor will take away this part of your business if you don’t find a way to keep up with the increased demand. You could easily sell 40,000 sticks per week, and you are 90% confident that the Zumba craze will last for at least 10 years. You can replace your current machine for $500,000, and it will have a capacity to produce 50,000 sticks per 8 hour shift. Your current machine is completely paid for. Maintenance costs will be lower for a new machine, but the utility costs will increase, so you think the net operating costs for the new machine will be similar to the older machine. 1. Do you purchase the new machine or not? Explain and justify your decision. 2. What factors do you need to consider? Are there other solutions? 3. What are the risks involved in purchasing the new machine? In not purchasing the new machine? 4. Summarize this scenario.

Explanation / Answer

Incremental Revenue= 114000-22800= $91200

1- We should Purchase the New Machine because if we assume that we can sell all production 50000 sticks and required ratte of return 10% then Present value of Incremental Cash flow will be $560385 (91200*6.1446) which is more than Initial Cost of Machine $500000.

2- Normal Market demand 40000 sticks where old machine can produce only 10000 sticks, if we not purchase new machine the company will lose market share and compititor will attract the existing customer by saying that the will fullfill whole demand. By purchasing new machine company will able to reduce fixed cost per unit and also tax saving on Depreciation.

2- Risk in purchasing new machine is only that company may not able to sale all production as given that market demand is 40000 sticks while production is 50000 sticks.

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