Question
King Catering makes cutlery for restaurants and hotels, it is currently using a model 26XL shaping machine to make one of its products. It bought
King Catering makes cutlery for restaurants and hotels, it is currently using a model 26XL shaping machine to make one of its products. It bought the equipment four years ago for $165,000. The present book value is $99,000, its present market value is $90,000.
We are January 1st 2022: The company is expected to have a large increase in demand for the product and is anxious to expand its productive capacity.
There are two possibilities under consideration:
- Purchase another model 26XL shaping machine to operate along with the currently owned machine for a price of $180,000.
- Purchase a new better performing machine the model C60 with double capacity of 26XL for $250,000, and use the 26XL as standby equipment.
- Both models have a 10 year life when bought new, with straight line depreciation.They have a negligible scrap value and it can be ignored.
- If the company decides not to buy the model C60, then the old 26XL model will have to be replaced in 6 years at an estimated cost of $200,000. The replacement machine will have a market value of about $100 000 when it is four years old.
- Production in units are estimated to be:
2022: 20,000 units
2023: 30,000 units
2024: 40,000 units
2025 to 2031 : 45,000 units per year
- Variable costs per unit for model 26XL are $0.36 for direct materials , $0.50 for direct labor, and $0.04 for supplies and lubricant per unit.
- Variable costs per unit for model C60 are $0.40 for direct material , $0.22 for direct labor, and $0.08 for supplies and lubricant per unit.
- Model 26XL is less costly to maintain, with annual maintenance and repair of $3000.
- Repair and maintenance on Model C60 with a model 26XL used as standby would total $4600 per year.
The required rate of return for the project is 10%.
1) Using NPV, which alternative should be used? SHOW COMPUTATIONS (25 points)
2) Suppose that the cost of labor increases by 30%, how would it change your answer?
SHOW COMPUTATIONS (20 points)
3) Suppose that the cost of direct materials increase by 50%, how would it change your answer?SHOW COMPUTATIONS (20 points)
4) Suppose that a tax rate of 30% is applied, how would it change your answer?
SHOW COMPUTATIONS (25 points)
5) How would an inflation going up to 15% affect your capital budgeting decision? Explain without computations. (10 points)
All assignment will be on paper with cover page AND YOUR NAME, NO PDF FIL
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