A company is planning to install a new automated plastic-molding press. Four dif

Question

A company is planning to install a new automated plastic-molding press. Four different presses are available. Assume that each press has the same output capacity (120,000 units per year), but the estimated reject rate is different for each alternative. The data for the four presses are summarized below. Press P1 P2 P3 P4 Capital investment $24,000 $30,A00 $49,600 $52,000 Total annual expenses $31,200 $29,128 $25,192 $22880 Reject rate 8.4% 0.3% 2.6% 5.6% Any additional capital invested is expected to earn at least 15% per year. The life of each press (and the study period) is five years and all four presses have no market value at the end of their useful life. Develop an Excel sheet to re-evaluate the recommended alternative if (a) the selling price is $0.375 per good unit and only non-defective units can be sold. (b) the selling price is $0.50 per good unit and only non-defective units can be sold. (c) the selling price is S0.50 per good unit and rejected units can be sold as scrap for $0.10 per unit. Submit a report on your findings with the Excel sheet.

Explanation / Answer

In this question we will use NPV analysis to choose between the alternatives

NPV is sum of present value of cash flows

Present value = cash flow/(1+r)n, where r is required rate of return and n is number of years

For project 1,

Capital Investment = $24,000

Annual Expenses = $31,200

Reject rate = 8.4%

For project 2,

Capital Investment = $30,400

Annual Expenses = $29,128

Reject rate = 0.3%

For project 3,

Capital Investment = $49,600

Annual Expenses = $25,192

Reject rate = 2.6%

For project 4,

Capital Investment = $52,000

Annual Expenses = $22,880

Reject rate = 5.6%

Output capacity for all project = 120,000

r = 15%

a) Selling price = $0.375

For project 1,

Revenue = 120,000*0.375 = $45,000

After rejection revenue = 45000 - 45000*(0.084) = $41,220

Profit = 41220 - 31200 = 10020

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4 + CF5/(1+r)5

NPV = -24,000 + 10020/(1.15)1 + 10020/(1.15)2 + 10020/(1.15)3 + 10020/(1.15)4 + 10020/(1.15)5

NPV = 9588.59

For project 2,

Revenue = 120,000*0.375 = $45,000

After rejection revenue = 45000 - 45000*(0.003) = $44,865

Profit = 44865 - 29128 = 15737

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4 + CF5/(1+r)5

NPV = -30,400 + 15737/(1.15)1 + 15737/(1.15)2 + 15737/(1.15)3 + 15737/(1.15)4 + 15737/(1.15)5

NPV = 22352.86

For project 3,

Revenue = 120,000*0.375 = $45,000

After rejection revenue = 45000 - 45000*(0.026) = $43,830

Profit = 43830 - 25192 = 18638

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4 + CF5/(1+r)5

NPV = -49,600 + 18638/(1.15)1 + 18638/(1.15)2 + 18638/(1.15)3 + 18638/(1.15)4 + 18638/(1.15)5

NPV = 12877.47

For project 4,

Revenue = 120,000*0.375 = $45,000

After rejection revenue = 45000 - 45000*(0.056) = $42,480

Profit = 43830 - 22880 = 19600

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4 + CF5/(1+r)5

NPV = -52,000 + 19600/(1.15)1 + 19600/(1.15)2 + 19600/(1.15)3 + 19600/(1.15)4 + 19600/(1.15)5

NPV = 13702.24

Below is the excel table containing all computations

Out of all the alternatives, alternative 2 is best as it has highest NPV

b) Similar to 'a' we can calculate NPV for this part

Revenue would be = 0.5*120,000 = 60,000

Below is the table containing claculation for NPV

NPV is highest for project 2 so we will choose that alternative

c) In this part rejected unit can also be sold for $0.1

For project 1,

Rejected unit = 120,000*0.084 = 10080

Revenue without rejected unit = (120000-10080)*0.5 = 54960

Revenue from rejected unit = 10080*0.1 = 1008

Total revenue = 54960+1008 = 55968

Profit = 55968 - 31200 = 24768

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 + CF4/(1+r)4 + CF5/(1+r)5

NPV = -24,000 + 24768/(1.15)1 + 24768/(1.15)2 + 24768/(1.15)3 + 24768/(1.15)4 + 24768/(1.15)5

NPV = 59026.18

Similarly we can calculate NPV for all other projects which is in below table

Out of all alternatives, alternative 2 is best

Project 1 Project 2 Project 3 Project 4 Year Revenue Revenue After Rejection Expenses Profit Present value factor Present value Revenue Revenue After Rejection Expenses Profit Present value factor Present value Revenue Revenue After Rejection Expenses Profit Present value factor Present value Revenue Revenue After Rejection Expenses Profit Present value factor Present value 0 -24000 1.00 -24000.00 -30400 1.00 -30400.00 -49600 1.00 -49600.00 -52000 1.00 -52000.00 1 45000 41220 31200 10020 0.87 8713.04 45000 44865 29128 15737 0.87 13684.35 45000 43830 25192 18638 0.87 16206.96 45000 42480 22880 19600 0.87 17043.48 2 45000 41220 31200 10020 0.76 7576.56 45000 44865 29128 15737 0.76 11899.43 45000 43830 25192 18638 0.76 14093.01 45000 42480 22880 19600 0.76 14820.42 3 45000 41220 31200 10020 0.66 6588.31 45000 44865 29128 15737 0.66 10347.33 45000 43830 25192 18638 0.66 12254.79 45000 42480 22880 19600 0.66 12887.32 4 45000 41220 31200 10020 0.57 5728.97 45000 44865 29128 15737 0.57 8997.68 45000 43830 25192 18638 0.57 10656.34 45000 42480 22880 19600 0.57 11206.36 5 45000 41220 31200 10020 0.50 4981.71 45000 44865 29128 15737 0.50 7824.07 45000 43830 25192 18638 0.50 9266.38 45000 42480 22880 19600 0.50 9744.66 NPV 9588.59 NPV 22352.86 NPV 12877.47 NPV 13702.24

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