Case Study: Alexander & Sons

Alexander & Sons Company is currently considering the purchase of equipment that produces mugs.

• The equipment needed would cost $3 million, with a disposal value of $400,000.
• The equipment would be able to produce 55 million mugs over its 5-year life.

The company has estimated that approximately 11 million mugs would be sold for each of the next 5 years, at the following prices:

• $1.00 for year 1 and 2
• $1.20 for year 3 and 4
• $1.25 for year 5

The company would hire seven new employees.

• These seven individuals would be full-time employees.
• Each will work 2,000 hours per year and earn:
  • $31 per hour in the first 3 years.
  • $32 per hour in year 4 and 5.

All employees would also receive annual benefits making up 20 percent of wages, in addition to an annual $10,000 cost for health benefits for each employee.

It is estimated that:

• The raw materials needed will cost 0.50 per mug.
• Other variable costs would be 0.20 per mug.
• No additional fixed costs would be incurred if this project is accepted.

The company's discount rate is 10 percent, and the current tax rate of 35 percent is anticipated to remain unchanged. The company uses the straight-line method for depreciation.

Case Study Questions

Based on the above information, calculate the following items:

• Annual net cash flows over the expected life of the equipment
• Payback period
• Net present value
• The accounting rate of return