Jonfran Company manufactures three different models of paper shredders including the waste container, which serves as the base. While the shredder heads are different for all three models, the waste container is the same. The number of waste containers that Jonfran will need during the following years is estimated as follows:
The equipment used to manufacture the waste container must be replaced because it is broken and cannot be repaired. The new equipment would have a purchase price of $945,000 with terms of 2/10, n/30; the company’s policy is to take all purchase discounts. The freight on the equipment would be $11,000, and installation costs would total $22,900. The equipment would be purchased in December 20x4 and placed into service on January 1, 20x5. It would have a five-year economic life and would be treated as three-year property under MACRS. This equipment is expected to have a salvage value of $12,000 at the end of its economic life in 20x9. The new equipment would be more efficient than the old equipment, resulting in a 25 percent reduction in both direct materials and variable
The old equipment is fully
Jonfran uses a plantwide fixed overhead rate in its operations. If the waste containers are purchased outside, the salary and benefits of one supervisor, included in fixed overhead at $45,000, would be eliminated. There would be no other changes in the other cash and noncash items included in fixed overhead except depreciation on the new equipment.
Jonfran is subject to a 40 percent tax rate. Management assumes that all
Required:
- 1. Prepare a schedule of cash flows for the make alternative. Calculate the
NPV of the make alternative. - 2. Prepare a schedule of cash flows for the buy alternative. Calculate the NPV of the buy alternative.
- 3. Which should Jonfran do—make or buy the containers? What qualitative factors should be considered? (CMA adapted)
1.
Calculate the cash flow and net present value (NVP) for make alternative of Company J.
Explanation of Solution
Cash inflows: The amount of cash received by a company from the operating, investing, and financing activities of the business during a certain period is referred to as cash inflow.
Cash outflows: The amount of cash paid by a company for the operating, investing, and financing activities of the business during a certain period is referred to as cash outflow.
Net present value method (NVP): Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.
Calculate the cash flow and net present value (NVP) for make alternative of Company J as follows:
Year |
Cash inflow (9) (A) | Present value factor @12% (B) |
Present value |
2015 | $ -499,013 | 0.893 | -$ 445,619 |
2016 | $ -456,312 | 0.797 | -$ 363,681 |
2017 | $ -594,130 | 0.712 | -$ 423,021 |
2018 | $ -658,546 | 0.636 | -$ 418,835 |
2019 | $ -679,800 | 0.567 | -$ 385,447 |
Total present value | -$ 2,036,602 | ||
Less: Cash outflow for investment (7) | $ 956,600 | ||
Net present value | ($ 2,993,202) |
Table (1)
Working note (1):
Calculate the variable cost per unit.
Working note (2):
Calculate the variable cost after tax for each year.
Year 2015:
Year 2016:
Year 2017:
Year 2018:
Year 2019:
Working note (3):
Calculate the fixed cost after tax for each year.
Working note (4):
Calculate the operating expense for each year.
Year | Variable cost (2) (E) |
Fixed cost (3) (F) |
Total operating expense |
2015 | $600,000 | $27,000 | $627,000 |
2016 | $600,000 | $27,000 | $627,000 |
2017 | $624,000 | $27,000 | $651,000 |
2018 | $660,000 | $27,000 | $687,000 |
2019 | $660,000 | $27,000 | $687,000 |
Table (2)
Working note (5):
Calculate the initial investment.
Working note (6):
Calculate the depreciation expense after tax for each year.
Depreciation Schedule | ||||
Year |
MACRS Percentage (W) |
Depreciation |
Tax Rate (Y) |
Depreciation Tax Shield |
2015 | 33.33% | $319,968 | 40% | $127,987 |
2016 | 44.45% | $426,720 | 40% | $170,688 |
2017 | 14.81% | $142,176 | 40% | $56,870 |
2018 | 7.41% | $71,136 | 40% | $28,454 |
Total | $960,000 |
Table (3)
Working note (7):
Calculate the cash outflow for new equipment.
Working note (8):
Calculate the salvage value after tax.
Working note (9):
Calculate the cash inflow of new equipment each year.
Year |
Operating expense after tax (P)(4) | Depreciation expenses after tax (Q) (6) | Salvage value after tax (R) (8) |
Net cash inflow |
2015 | ($627,000) | $127,987 | ($499,013) | |
2016 | ($627,000) | $170,688 | ($456,312) | |
2017 | ($651,000) | $56,870 | ($594,130) | |
2018 | ($687,000) | $28,454 | ($658,546) | |
2019 | ($687,000) | $7,200 | ($679,800) |
Table (4)
2.
Calculate the cash flow and net present value (NVP) for buy alternative of Company J.
Explanation of Solution
Calculate the cash flow and net present value (NVP) for buy alternative of Company J as follows:
Year |
Cash inflow (10) (A) | Present value factor @12% (B) (11) |
Present value |
2015 | $ -810,000 | 0.893 | -$ 723,330 |
2016 | $ -810,000 | 0.797 | -$ 645,570 |
2017 | $ -842,400 | 0.712 | -$ 599,789 |
2018 | $ -891,000 | 0.636 | -$ 566,676 |
2019 | $ -891,000 | 0.567 | -$ 505,197 |
Total present value | -$ 3,040,562 | ||
Less: Salvage value (11) | -$ 600 | ||
Net present value | -$ 3,039,962 |
Table (5)
Working note (10):
Calculate the cash inflow for each year.
Year 2015:
Year 2016:
Year 2017:
Year 2018:
Year 2019:
Working note (11):
Calculate the salvage value after tax for year 2014.
3.
Indicate whether company J should make the containers or buy the containers, and explain the quantitative factors that should be considered for the capital investment analysis.
Explanation of Solution
Indicate whether company J should make the containers or buy the containers, and explain the quantitative factors that should be considered for the capital investment analysis as follows:
In this case, company J should make the containers because make decision ($2,993,203) has less cost than the buy decision ($3,039,662). Qualitative factors of capital investment analysis are,
- Reliability of supplier,
- Quality of the product,
- Stability of purchasing price,
- Labor relations, and
- Community relation.
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Chapter 19 Solutions
Cornerstones of Cost Management (Cornerstones Series)
- Mallette Manufacturing, Inc., produces washing machines, dryers, and dishwashers. Because of increasing competition, Mallette is considering investing in an automated manufacturing system. Since competition is most keen for dishwashers, the production process for this line has been selected for initial evaluation. The automated system for the dishwasher line would replace an existing system (purchased one year ago for 6 million). Although the existing system will be fully depreciated in nine years, it is expected to last another 10 years. The automated system would also have a useful life of 10 years. The existing system is capable of producing 100,000 dishwashers per year. Sales and production data using the existing system are provided by the Accounting Department: All cash expenses with the exception of depreciation, which is 6 per unit. The existing equipment is being depreciated using straight-line with no salvage value considered. The automated system will cost 34 million to purchase, plus an estimated 20 million in software and implementation. (Assume that all investment outlays occur at the beginning of the first year.) If the automated equipment is purchased, the old equipment can be sold for 3 million. The automated system will require fewer parts for production and will produce with less waste. Because of this, the direct material cost per unit will be reduced by 25 percent. Automation will also require fewer support activities, and as a consequence, volume-related overhead will be reduced by 4 per unit and direct fixed overhead (other than depreciation) by 17 per unit. Direct labor is reduced by 60 percent. Assume, for simplicity, that the new investment will be depreciated on a pure straight-line basis for tax purposes with no salvage value. Ignore the half-life convention. The firms cost of capital is 12 percent, but management chooses to use 20 percent as the required rate of return for evaluation of investments. The combined federal and state tax rate is 40 percent. Required: 1. Compute the net present value for the old system and the automated system. Which system would the company choose? 2. Repeat the net present value analysis of Requirement 1, using 12 percent as the discount rate. 3. Upon seeing the projected sales for the old system, the marketing manager commented: Sales of 100,000 units per year cannot be maintained in the current competitive environment for more than one year unless we buy the automated system. The automated system will allow us to compete on the basis of quality and lead time. If we keep the old system, our sales will drop by 10,000 units per year. Repeat the net present value analysis, using this new information and a 12 percent discount rate. 4. An industrial engineer for Mallette noticed that salvage value for the automated equipment had not been included in the analysis. He estimated that the equipment could be sold for 4 million at the end of 10 years. He also estimated that the equipment of the old system would have no salvage value at the end of 10 years. Repeat the net present value analysis using this information, the information in Requirement 3, and a 12 percent discount rate. 5. Given the outcomes of the previous four requirements, comment on the importance of providing accurate inputs for assessing investments in automated manufacturing systems.arrow_forwardThaler Company bought 26,000 of raw materials a year ago in anticipation of producing 5,000 units of a deluxe version of its product to be priced at 75 each. Now the price of the deluxe version has dropped to 35 each, and Thaler is now deciding whether to produce 1,500 units of the deluxe version at a cost of 48,000 or to scrap the project. What is the opportunity cost of this decision? a. 175,000 b. 375,000 c. 48,000 d. 26,000arrow_forwardBT&T Corporation manufactures telephones. Recently , the company produced a batch of 600 defective telephones at a cost of $9,000. BT &T can sell these telephones as scrap for $9 each. It can also rework the entire batch at a cost of $6,500 , after which the telephones could be sold for $20 per unit. If BT&T reworks the defective telephones , by how much will its operating income change ?arrow_forward
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- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning