a) A company has 7000 obsolete toys carried in inventory at a manufacturing cost
ID: 2381302 • Letter: A
Question
a) A company has 7000 obsolete toys carried in inventory at a manufacturing cost of $6 per unit. If the toys are reworked for $2 per unit, they could be sold for $3 per unit. If the toys are scrapped, they could be sold for $1.85 per unit. Which alternative is more desirable(rework/scrap), and what is the total dollar amount of the advantage of that alternative?
b) A company is investing in a machine with a 3 year life. The machine is expected to reduce annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3. Present value factors follow:
For $1 for an annuity of $1
Period 1 0.88 0.88
Period 2 0.79 1.65
Period 3 0.67 2.32
Using a 14% cost of the capital, what is the present value of these future savings?
Explanation / Answer
a.
Cost of obsolete toys = 7,000 * $6 = $42,000
Cost of rework = 7,000 * $2 = $14,000
Sales after rework = 7,000 * $3 = $21,000
Profit = $21,000 - $42,000 + $14,000 = $7,000
Sales of scrap = 7,000 * $1.85 = $12,950
Profit = $42,000 - $12,950 = $29,050
Sale of scrap is more profitable than rework.
Advantage of scrap alternative = $12,950 - $7,000 = $5,950
b.
Present value of first two years = $30,000 * 1.65 = $49,500
Present value of third year = $20,000 * 0.67 = $13,400
Total present value = $49,500 + $13,400 = $62,900
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