A manufacturing firm is considering the production of a new electronic device. T
ID: 2754741 • Letter: A
Question
A manufacturing firm is considering the production of a new electronic device. This project has an estimated life of 7 years and requires an initial capital outlay of $5.2 million. The salvage value is negligible. The fixed production costs will amount to $1 million per year. However, the demand and the unit variable production costs (assumed constant within the plant's range of operating capacities) for such a new device are uncertain. A market survey and a detailed cost analyses have yielded the following information concerning these parameters (highest probability is most probable): The firm's cost of capital is 15% (i) and the selling price of the new device is $100 per unit. Assume that annual demand and unit variable production costs are independent. Please ignore income taxes. Determine the expected value (EV) for total annual operating costs. [$3,473,500] Determine the most-likely net present value. [$1,040,600]Explanation / Answer
a. EXPECTED VALUE OF TOTAL ANNUAL OPERATING COSTS:
Expected Annual Demand = (40000*0.2+50000*0.5+60000*0.3) = 51000 units
Expected Unit Variable Cost = (40*0.1+45*0.2+50*0.6+55*0.1) = $48.50 per unit
Total expected value for total operating costs = 51000 * $48.50 + 1,000,000 Fixed Cost
= $3,473,500
b. Most likely Net Present Value:
Most Likely Annual Demand is 50000 units and Variable cost per unit is $50. Given Selling Price is $100 per unit, so annual cash flow considering the fixed cost $1 million =
= (100-50) 50000 - 1,000,000 =$1,500,000
Present value of cash flow over 7 years = $1,500,000 * 4.160 PVIFA(15%,7)
= $6,240,000
Most likely Net present value = $6,240,000 - $5,200,000 = $1,040,000
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