How to determine what the Variable Costs are?

How to determine what the Fixed Costs are?

Exhibit 1 Sales forecasts:

The forecasts are based on projected levels of demand. The firm could face weak, average, and strong demand. All the numbers are expressed in todays dollars. The forecasted average inflation per year is 4.0%.

Demand levelWeakAverageStrongProbability25%45%30%Price per electric motor$9,100$9,200$9,250Units sold per year40,00040,50040,750Labor cost per electric motor$4,250 Parts$2,500 Selling General & Administrative$9,500,000 Average warranty cost per year per electric motor for the first five years is $75. The present value of this cost will be used as a cost figure for each electric motor. Afterwards, the electric motor owners will become responsible the repairs.The electric motors can be produced for eight years. Afterwards, the designs become obsolete.

Exhibit 2 Controller costs:

Controller choices:

Controller model numberCTX 13 MT 78 Price per controller and installation$1280$1260Average annual warranty cost per year for five years. Afterwards, the electric motor owner will become responsible the repairs*.$90$100

The chosen controller will be installed in every electric motor and will become a cost figure for each unit produced.

* The controller manufacturers are not providing Electrics with any warranty. However, Electrics will provide a warranty to its customers. After the initial five years, the electric motor owners may purchase extended warranty from any insurance company that offers such packages.

Exhibit 3 Investment needs:

To implement the project, the firm has to invest funds as shown in the following table:

Year 0Year 1$17 millionProduction and selling of commercial appliances begins

MACRS depreciation will be used. Project life is eight years, zero salvage value.

To facilitate the operation of manufacturing the electric motors, the company will have to allocate funds to net working capital (NWC) equivalent to 10% of annual sales. The investment in NWC will be recovered at the end of the project.

Exhibit 4 Financing

The following assumptions are used to determine the cost of capital. Historically, the company tried to maintain a debt-to-equity ratio equal to 1.50. This ratio was used because lowering the debt implies giving up the debt tax shield and increasing it makes debt service a burden on the firms cash flow. In addition, increasing the debt level may cause a reduced rating of the companys bonds. The marginal tax rate is 25%. All the numbers are expressed in todays dollars. The forecasted average inflation per year is 4.0%.

Cost of debt:

The companys bond rating is roughly at the high end of the BBB range. Surveying the debt market yielded the following information about the cost of debt for different rating levels:

Bond ratingAAABBBInterest cost range4.5% ~ 5.5%5.25% ~ 6.5%6.5% ~ 9%

The companys current bonds have a rating of BBB.

Cost of equity:

The current 10-year Treasury notes have a yield to maturity of 4.00% and the forecast for the S&P 500 market premium is 9.5%. The companys overall b is 1.25.