An automobile manufacturer is converting an assembly line from standard vehicles

Question

An automobile manufacturer is converting an assembly line from standard vehicles to hybrid vehicle production. Conversion will cost $100 million. Production capacity will be 4000 vehicles in the first year and will increase by 1000 vehicles per year for all future years. Each hybrid earns a net profit of $5,000.

a. If the interest rate is 15%, how many years will it take until the present worth of the net benefits equals the $100 million initial cost? Report your answer to 2 decimal places.

b. Using the simple payback method, how many years will it take the $100 million investment to pay back? Report your answer to 2 decimal places. (2 points)

c. Based on your answers to parts a. and b. would you recommend this investment? Why or why not? (2 points)

Explanation / Answer

a) Consider the following table:

Cash inflow is calculated as = net benefit of hybrid * production capacity in terms of vehicles.

It is clear that positive returns get started in year 6th which means between year 5 and 6th  the present worth of the net benefits equals the $100 million initial cost.

Pay back period = 5 years + 4079500/19453500 = 5 years + 0.20 = 5 years 2 months approximately.

b) Simple pay back period without involving interest rate is calculated as below:

Simple pay back period = 3 years + 25000000/35000000 = 3 years and 7 months approximately.

c) The investment moneys returns early hence this project should be considered.

Year Cash flow Pv factor at 15% PV of cash flow Cumulative cash flow 0 -100000000 1 -100000000 -100000000 1 20000000 0.8696 17392000 -82608000 2 25000000 0.7561 18902500 -63705500 3 30000000 0.6575 19725000 -43980500 4 35000000 0.5718 20013000 -23967500 5 40000000 0.4972 19888000 -4079500 6 45000000 0.4323 19453500 15374000 7 50000000 0.3759 18795000 34169000 8 55000000 0.3269 17979500 52148500

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