Chrysler is considering a cost reduction program. The suppliers must reduce the

Question

Chrysler is considering a cost reduction program. The suppliers must reduce the cost of the components that they furnish to Chrysler by 4% each year. (The total amount of savings would increase each year.) The initial costs: Chrysler is currently paying a total of $85,000,000 per year for components purchased from the vendors who will be involved in this program. (Assume that, if the program is not approved, the annual cost of purchased components will remain constant at $85,000,000 per year.) The program has been designed as a five-year initiative, and Chrysler's MARR for such projects is 12% (i_m). There will be annual operating expenses associated with the program for further training of vendors, updating internal documentation, and so on. Given the projected savings in purchased components, what would be the maximum annual operating expense for this program such that it is marginally justified? Assume that the EOY 1 cost for purchased components is $85,000,000. The PW if the program is approved is $ million. (Round to one decimal place.)

Explanation / Answer

Answer: $817,366 Calculations: 1 2 3 4 5 cost of components 85,000,000 81600000 78336000 75202560 72194458 savings 0 3,400,000 6,664,000 9,797,440 12,805,542 pvif @ 12% 0.8929 0.7972 0.7118 0.6355 0.5674 3.6048 pv 0 2710459 4743304 6226450 7266208.7 sum of pvs of savings 20946422 initial cost 18000000 (11500000+6500000) npv without annual 2946422 operating expenses This NPV is the PV of the maximum annual operating expenses costs that can be incurred to make the NPV = 0 at the minimum. So maximum annual operating expenses that can be incurred = 2946422/pvifa(12,5) = 2946422/3.6048 = 817366

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