5.Net Present Value and Competing Alternatives Follow the format shown in Exhibi

Question

5.Net Present Value and Competing Alternatives Follow the format shown in Exhibit 12B-1 and Exhibit 12B-2 as you complete the requirements below. Stillwater Designs has been rebuilding Model 100, Model 120, and Model 150 Kicker subwoofers that were returned for warranty action. Customers returning the subwoofers receive a new replacement. The warranty returns are then rebuilt and resold (as seconds). Tent sales are often used to sell the rebuilt speakers. As part of the rebuilding process, the speakers are demagnetized so that metal pieces and shavings can be removed. A demagnetizing (demag) machine is used to achieve this objective. A product design change has made the most recent Model 150 speakers too tall for the demag machine. They no longer fit in the demag machine.

Stillwater Designs is currently considering two alternatives. First, a new demag machine can be bought that has a different design, eliminating the fit problem. The cost of this machine is $600,000, and it will last 5 years. Second, Stillwater can keep the current machine and sell the 150 speakers for scrap, using the old demag machine for the Model 100 and 120 speakers only. A rebuilt speaker sells for $295 and costs $274.65 to rebuild (for materials, labor, and overhead cash outlays). The $274.65 outlay includes the annual operating cash effects of the new demag machine. If not rebuilt, the Model 150 speakers can be sold for $4 each as scrap. There are 10,000 Model 150 warranty returns per year. Assume that the required rate of return is 10%.

Required:

1. Determine which alternative is the best for Stillwater Designs by using NPV analysis. If required, round to the nearest dollar.

NPV (rebuild alternative)

NPV (scrap alternative)

2. CONCEPTUAL CONNECTION: Determine which alternative is best for Stillwater Designs by using an IRR analysis. Enter as a percent. Round your answers to the nearest whole percent. If IRR is infinite, leave the cell blank.

IRR (rebuild alternative) %

IRR (scrap alternative) %

Explanation / Answer

a) Annual Cash flow (rebuild alternative) = ($295 – $274.65) x 10,000 $203,500 Year Cash flow PV @ 10% Present Value 0 -$600,000 1 -$600,000 1 $203,500 0.909090909 $185,000 2 $203,500 0.826446281 $168,181.82 3 $203,500 0.751314801 $152,892.56 4 $203,500 0.683013455 $138,993.24 5 $203,500 0.620921323 $126,357.49 NPV (rebuild alternative) $171,425.11 Annual Cash flow (scrap alternative) = $4 × 10,000 = $40,000 Year Cash flow PV @ 10% Present Value 0 $0 1 $0 1 $40,000 0.909090909 $36,363.64 2 $40,000 0.826446281 $33,057.85 3 $40,000 0.751314801 $30,052.59 4 $40,000 0.683013455 $27,320.54 5 $40,000 0.620921323 $24,836.85 NPV $151,631.47 NPV (rebuild alternative) is the best as its higher than the scrap alternative so the new demag machine should be purchased. b) Year Cash flow 0 -$600,000 1 $203,500 2 $203,500 3 $203,500 4 $203,500 5 $203,500 IRR (Rebuild Alternative) 20.65% Year Cash flow 0 $0 1 $40,000 2 $40,000 3 $40,000 4 $40,000 5 $40,000 IRR (Scrap Alternative) Infinite The scrap alternative is better under the IRR criterion but its infinite IRR doesn't make sense. The NPV approach is better as it measures the absolute improvement in dollars.

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