Question
Gertrude Corp. is pondering a factory overhaul that will cost 1 million this year (2021) and disrupt production while the overhaul is occurring. This disruption
Gertrude Corp. is pondering a factory overhaul that will cost 1 million this year (2021) and disrupt production while the overhaul is occurring. This disruption will cost the firm $500,000 in contribution margin this year. Starting in 2022, Gertrude will benefit from the overhaul by seeing its variable cost per unit fall by 20%. Annual fixed costs will increase for maintenance ($200,000 the first year increasing by $100,000 each year thereafter, so 300,000 in the 2nd year, etc.) and $100,000 for depreciation (same every year).
Absent an overhaul, the factory produces 1 million units per year at variance cost of $8 per unit, fixed cost of $1.5 million, with the output sold for $10 per unit. After an overhaul, the company would intend to cut the price to $4.50 per unit, enabling the firm to produce and sell 2.5 million units annually. The factory is old and is expected to be shut down at the end of 2025 regardless of the overhaul decision. The factory would then be sold to another firm. Without an overhaul, the sale price for the factory would be $2.5 million. With an overhaul, the sale price for the factory would be $2.8 million.
Please prepare NPV calculation, please show how to calculate each year's cash flow.
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