Overview: Wicked Good Cupcakes (WGC) expanded 1 year ago with the purchase of 3
ID: 1170703 • Letter: O
Question
Overview: Wicked Good Cupcakes (WGC) expanded 1 year ago with the purchase of 3 baking/packaging systems. A vendor, Acme Baking, has suggested that there would be significant cost savings by the purchasing and installation of their newer integrated baking technology. The existing systems and Acme's proposed integrated baking technology have an expected useful life of 10 years, with no salvage value. WGC tax rate is 45% and their IRR is 10%. Here is a summary of the financials: Present System Acme Baking Gross Profit Less Depreciation Profit before tax Tax @ 45% Profit After Tax Add Depreciation After Tax cash flow $600,000 $1,200,000 $300,000 $300,000 $135,000 $165,000 $300,000$450,000 $465,000 $450,000 $750,000 $338,000 $412,000 $862,000 Instructions: Based on the unit's material and what you have read above: 1. Should WGC invest in Acme's technology; base your decision on determining the NPV as well as difference in cash flows between the present system and Acme's new technology. 2. Does the increase in Gross Profit alone justify the new technology? Requirements: Length: two to three-page narrative of your findings and observations . All questions posed must be addressed completely. e All sources used must be properly cited in APA format Be sure to read the criteria, by which your assignment will be evaluated before you write, and again after you write.Explanation / Answer
Solution : Calulation of Net Present Value Present System After Tax Cash Flow Year Present Value Factor Present Value 465000 1 0.909090909 422,727.27 465000 2 0.826446281 384,297.52 465000 3 0.751314801 349,361.38 465000 4 0.683013455 317,601.26 465000 5 0.620921323 288,728.42 465000 6 0.56447393 262,480.38 465000 7 0.513158118 238,618.52 465000 8 0.46650738 216,925.93 465000 9 0.424097618 197,205.39 465000 10 0.385543289 179,277.63 Present Value of All Cash Flows 2,857,223.70 Less : Current Investment 3,000,000.00 Net Present Value (142,776.30) Acme Banking System After Tax Cash Flow Year Present Value Factor Net Present Value 862000 1 0.909090909 783,636.36 862000 2 0.826446281 712,396.69 862000 3 0.751314801 647,633.36 862000 4 0.683013455 588,757.60 862000 5 0.620921323 535,234.18 862000 6 0.56447393 486,576.53 862000 7 0.513158118 442,342.30 862000 8 0.46650738 402,129.36 862000 9 0.424097618 365,572.15 862000 10 0.385543289 332,338.32 Present Value of All Cash Flows 5,296,616.85 Less : Current Investment 4,500,000.00 Net Present Value 796,616.85 Difference in Cash Flows between the two methods Gross Cash Flow as per Acme Banking 5,296,617 Gross Cash Flow as per Present System 2,857,224 Increase due to Acme Banking 2,439,393 Answer 1 : WGC should invest in the new Techology as the Net Present Value in case of Acme Banking $796616.85 is greater than that of Present System -$142776.29. Answer 2: Increase in gross profit alone does not justify new technology due to the following : Even though the gross profit might have increased but there might be case wherein increase in investment might have greater than increase in gross profit. In this scenario inspite of increase in gross profit company might incur a loss. For Example : Company A purchased a machine for $100 which has a 2 years of life and yearly gross profit from the machine is $120.Company got a quotation to purchase a new machine For $250 having 2 years of life which would give a gross profit of $122 each year. In this case even though the gross profit increased by $2 purchasing the new machine would cause a loss as the increase is gross profit is less than increase in cost of Machine.
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