CHAPTER 9 Question 3 Net present value AutoQuest has been selling auto parts to the general public for over 70 years. It has built a reputation for outstanding customer service, becoming the third largest auto parts retailer in the Southwest. Hoping to expand its sales to other regions, managers have decided to establish an online retail presence. Dan Jennings, CIO of AutoQuest, is charged with the task of evaluating how the company should implement this strategy- One of the first things Dan needs to determine is how to acquire the network servers the company will need. He knows the vendor he wants to use, but he is uncertain whether he should buy or lease the servers. If he buys the servers for $4.3 million, AutoQuest will incur annual maintenance costs of $50,000 over their five-year life. If he leases the servers for five years, AutoQuest will make lease payments of $1.2 million in each of the first three years and $1 million in each of the last two years. Annual maintenance costs under the lease will be $80,000. Required; 1. Which option will cost the company less to implement, assuming a 12% discount rate? 2. What salvage value would AutoQuest need to receive on the purchased servers at the end of year 5 so that the purchase option is essentially equal to the lease option? Assume a 12% discount rate. 3. What annual cash inflow from the new online sales would be necessary for the lease option to be financially acceptable? Assume a 12% discount rate. What non-financial issues might Dan Jennings consider in deciding whether to purchase or lease the servers?Question 4 Net present value, internal rate of return, payback period, accounting rate of return Farrior Fashions needs to replace a beltloop attacher that currently costs the company $50,000 in annual cash operating costs. This machine is of no use to another company, but it could be sold as scrap for $3,128. Managers have identified a potential replacement machine, Euromat's Model HD-435. The HD-435 is priced at $90,000 and would cost Farrior Fashions $30,000 in annual cash operating costs. The machine has a useful life of 8 years, and it is not expected to have any salvage value at the end of that time. Required; 1. Calculate the net present value of purchasing the HD-435, assuming Farrior Fashions uses a 12% discount rate. 2. Calculate the internal rate of return on the HD-435. 3. Calculate the payback period of the HD-435. 4. Calculate the accounting rate of return on the HD-435. 5. Should Farrior Fashions purchase the HD-435? Why or why not? Question 5 Capital investment analysis After one year using the TopCap system, Jonathan Smith, vice president for marketing at C&C Sports, is convinced that the company could sell even more baseball caps. Apparently, the market demand for plain caps that are suitable for logo embroidery by corporations, fraternities, and other groups is greater than current manufacturers can supply. The potential for C&C Sports to extend its sales of baseball caps beyond the athletic team market is huge. The initial specifications for the TopCap system required three workers per eight-hour shift to make up to 1,000 caps per day. Based on initial demand forecasts, Jonathan asked Chad Davis, vice president for operations, to make 240,000 caps in the first year the product was offered. Jonathan is convinced that C&C could sell at least 480,000 caps per year with the correct investment in marketing.Required; 1. By how much would annual operating income increase if a second shift was used to produce additional caps? Refer to Exhibit 9.2 for current revenue and cost information. Assume that the relevant range for the fixed costs is 750,000 caps. What additional one-time marketing cost could be justified to increase sales to meet anticipated demand? Remember that there are only 9 years of usable life remaining for the TopCap system and that C&C Sports uses a 12% discount rate. CHAPTER 10 Question 6 Calculating return on investment, residual income, and economic value added Segment A Segment B Segment C Segment D Segment E Sales revenue $1,000,000 $1,500,000 i. $400,000 $310,000 Operating income $100,000 f. $420,000 $60,000 0. Tax rate 30% 25% 20%% 20% Average assets $500,000 $1,400,000 $500,000 $124,000 Current liabilities $40,000 $40,000 $40,000 $10,000 Corporate required return 15% 18% 16% m. 20% Weighted-average cost of 12% 14% 15% 10% 18% capita Margin a. 5% k. 15% 2%% Asset turnover b. 3 1.5 n. 2.5 Return on investment C. h. 30% 12% p. Residual income d. $(15,000) $196,000 $0 $ (18,600 Economic value added e . $(8,150 $142,800 $(4,00 0) Required 1. Compute the missing amounts labeled a-q. Question 7 Comprehensive case Thompson Manufacturing has been in business for over 50 years, making a variety of consumer electronics products. Mary Felix recently joined the business as vice president of the Conley division, one of the company's newest divisions. During her first week on the job, Mary met with CEO Mitch Thompson to discuss the division's future. "I know we're one of the newest and smallest divisions in the company," Mary said, "but I think we're in a position to realize some dramatic growth through product line expansion. We've got a full pipeline of products under development, and I'd like to speed up development of a couple of those products. If we work hard, I think we can have the new express charger ready for release by the end of the year." Mitch thought for a minute and then replied. "That sounds like a good idea, Mary. I just don't want you to move so fast that you don't have a good understanding of how the introduction of the new productwill affect the division's performance. Remember, I'm a big fan of maintaining our return on investment." Mary went back to her office after the meeting and began to review the express charger. At a sales price of $10 per unit, the marketing department estimates demand for the product at 50,000 units. The division will need to purchase a new machine for $100,000 to produce the charger. Mary also estimates that the division will incur an additional $150,000 in fixed costs that are directly attributable to the charger. One component of the charger is currently produced by Thompson's Amber division at a variable cost of 54 per unit. The component is sold to outside customers for $6 per unit. Mary had met with Caroline Smith, vice president of the Amber division, earlier in the week to discuss the possibility of the Amber division supplying the component to the Conley Division. "Sure," Caroline began, "I'd like to help you out on this. We can provide the components at our market price of $6 per unit. We have the capacity to make 150,000 of the components, and we're currently making only 130,000 for our external customers." Mary thanked Caroline for her time saying, "I'll get back to you next week." The Conley division currently earns $250,000 on $2.5 million in sales revenue. The division has an asset base of $1,250,000. Mary knows that Mitch will not be happy if the new product reduces the division's return on investment, and she is concerned that Caroline's offer to sell the component at $6 per unit will push product costs too high to maintain the division's ROI. She thinks that if she can meet with Caroline again to explain the situation, maybe she can negotiate a lower transfer price. Required 2. What is the Conley division's current return on investment? 3. Given the projected demand for the charger and the current cost estimates for the product, what is the maximum total variable cost that Mary can incur and still maintain the division's ROI? what would be the resulting contribution margin per unit for the charger? 4. What is the minimum transfer price that the Amber division should be willing to charge the Conley division for the 50,000 components it needs to produce the charger? 5. Regardless of your answer to part (b), assume that Mary has determined that the maximum acceptable variable cost per unit is $6.60 and that all but $2 of that cost will be attributable to the component transferred from the Amber division. Will Mary accept the Amber division's minimum transfer price? 6. Suppose that Mitch has decided to evaluate division vice presidents based on residual income rather than return on investment. If he requires a 15%% minimum rate of return, will Mary be able to accept the Amber division's minimum transfer price? Why or why not? 7. What do you recommend