The company is considering the purchase of machinery and equipment to set up a line to produce a combination washer-dryer. They have given you the following information to analyze the project on a 5-year timeline:
Initial cash outlay is $150,000, no residual value.
Sales price is expected to be $2,250 per unit, with $595 per unit in labor expense and $795 per unit in materials.
Direct fixed costs are estimated to run $20,750 per month.
Cost of capital is 8%, and the required rate of return is 10%.
They will incur all operational costs in Year 1, though sales are expected to be 55% of break-even.
Break-even (considering only direct fixed costs) is expected to occur in Year 2.
Variable costs will increase 2% each year, starting in Year 3.
Sales are estimated to grow by 10%, 15%, and 20% for years 3 - 5.
Then to calculate:
The product’s contribution margin
Break-even quantity
NPV
IRR
Finally:
Explain how the project analyses do or do not support this decision.
In either case, what are the factors that should have been considered in management’s decision?

This project should be rejected because it has a negative NPV and IRR. You would not be able to even recover your own investment, the sales output is too small.

Explanation:

initial outlay -$150,000

selling price per unit $2,250

production costs:

labor $595
materials $795

total fixed costs $20,750

contribution margin per unit = $2,250 - ($595 + $795) = $860

contribution margin year 3 = $2,250 - $1,417.80 = $832.20

contribution margin year 4 = $2,250 - $1,446.16 = $803.84

contribution margin year 4 = $2,250 - $1,475.08 = $774.92

in order to calculate the break even point in units we must determine the total fixed costs per year = $20,750 x 12 = $249,000

break even point in units = $249,000 / $860 = 289.5 ≈ 290 units

sales during first year = 290 x 55% = 159.5 ≈ 160 units

sales during second year = 290 units

sales during third year = 290 x 1.1 = 319 units

sales during fourth year = 319 x 1.15 = 366.85 ≈ 367 units

sales during fifth year = 367 x 1.2 = 440.4 ≈ 440 units

net cash flow year 1 = $137,600 - $249,000 = -$111,400

net cash flow year 2 = $249,400 - $249,000 = $400

net cash flow year 3 = $265,471.80 - $249,000 = $16,471.80

net cash flow year 4 = $295,009.28 - $249,000 = $46,009.28

net cash flow year 5 = $340,964.80 - $249,000 = $91,964.80

using a financial calculator and a 10% discount rate, NPV = -$150,038.78 and IRR = -12.07%

lhmarianateixeira lhmarianateixeira · Answer 2 · 2022-01-09T03:44:11+01:00

In this exercise we have to use finance knowledge to calculate the quantity and taxes calculated on the product, so we have to:

1) [tex]Break-even \ quantity = 290 units\\NPV = -$150,038.78 \\IRR = -12.07%[/tex]

2) This project should be rejected because it has a negative NPV and IRR. You would not be able to even recover your own investment, the sales output is too small.

Given the values in the text of:

Initial outlay [tex]\$150,000[/tex]

Selling price per unit [tex]\$2,250[/tex]

Labor [tex]\$595[/tex]

Materials [tex]\$795[/tex]

Total fixed costs [tex]\$20,750[/tex]

Now calculating the margin for each unit we find that:

Contribution margin per unit: [tex]\$2,250 - (\$595 + \$795) = \$860[/tex]

Contribution margin year 3: [tex]\$2,250 - \$1,417.80 = \$832.20[/tex]

Contribution margin year 4: [tex]\$2,250 - \$1,446.16 = \$803.84[/tex]

Contribution margin year 5: [tex]\$2,250 - \$1,475.08 = \$774.92[/tex]

Knowing that break even point in units it is worth it 290, we have to:

Sales during year 1: [tex]290 * 55\% = 159.5 = 160 \ units[/tex]

Sales during year 2: [tex]290 \ units[/tex]

Sales during year 3: [tex]290 * 1.1 = 319 \ units[/tex]

Sales during year 4: [tex]319 * 1.15 = 366.85 = 367 \ units[/tex]

Sales during year 5: [tex]367* 1.2 = 440.4= 440\ units[/tex]

So to calculate the net cash we found that:

Net cash flow year 1: [tex]\$137,600 - \$249,000 = -\$111,400[/tex]

Net cash flow year 2: [tex]\$249,400 - \$249,000 = \$400[/tex]

Net cash flow year 3: [tex]\$265,471.80 - \$249,000 = \$16,471.80[/tex]

Net cash flow year 4: [tex]\$295,009.28 - \$249,000 = \$46,009.28[/tex]

Net cash flow year 5: [tex]\$340,964.80 - \$249,000 = \$91,964.80[/tex]

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