(Ignore income taxes in this problem.) A newly developed device is being conside
ID: 2381957 • Letter: #
Question
(Ignore income taxes in this problem.) A newly developed device is being considered by Fairway Foods for use in processing and canning peaches. The device, which is available only on a royalty basis, is reported to be a great labor saver. Fairway's production manager has gathered the following data:
Present labor
method Proposed royalty method
Per year:
Labor cost $ 40,000 $ 5,000
Royalty cost - $ 20,000
Initial startup costs associated with the new device - $ 100,000
The new device must be obtained through a licensing arrangement with the developer. The license period lasts for only 8 years. Fairway Foods' required rate of return is 10%.
Required:
a.
By use of the incremental cost approach, compute the net present value of the proposed licensing of the new device. (Round "PV Factor" to 3 decimal places. Round your other intermediate calculations and final answers to the nearest whole dollar.) (Use Exhibit 11B-2)
Net present value $
b. Should the company enter into a licensing arrangement to use the new device?
Yes
No
Explanation / Answer
By opting for the royalty method, annual cost savings = (40,000-5,000)+(0-20,000) = 15,000
a. NPV of the approach = -100,000 + 15,000/(1+10%)^1 + 15,000/(1+10%)^2 + 15,000/(1+10%)^3 + 15,000/(1+10%)^4 + 15,000/(1+10%)^5 + 15,000/(1+10%)^6 + 15,000/(1+10%)^7 + 15,000/(1+10%)^8 = $ -19,976
b. As the NPV is negative, the company should NOT enter into the arrangement.
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