NPV, Make or Buy, MACRS, Basic Analysis

Jonfran Company manufactures three different models of paper shredders including the waste container, which serves as the base. While the shredder heads are different for all three models, the waste container is the same. The number of waste containers that Jonfran will need during the following years is estimated as follows:

20x5	50,000
20x6	50,000
20x7	52,000
20x8	55,000
20x9	55,000

The equipment used to manufacture the waste container must be replaced because it is broken and cannot be repaired. The new equipment would have a purchase price of $945,000 with terms of 2/10, n/30; the company's policy is to take all purchase discounts. The freight on the equipment would be $11,000, and installation costs would total $22,900. The equipment would be purchased in December 20x4 and placed into service on January 1, 20x5. It would have a five-year economic life and would be treated as three-year property under MACRS. This equipment is expected to have a salvage value of $12,000 at the end of its economic life in 20x9. The new equipment would be more efficient than the old equipment, resulting in a 25 percent reduction in both direct materials and variable overhead. The savings in direct materials would result in an additional one-time decrease in working capital requirements of $2,500, resulting from a reduction in direct material inventories. This working capital reduction would be recognized at the time of equipment acquisition.

The old equipment is fully depreciated and is not included in the fixed overhead. The old equipment from the plant can be sold for a salvage amount of $1,500. Rather than replace the equipment, one of Jonfran's production managers has suggested that the waste containers be purchased. One supplier has quoted a price of $27 per container. This price is $8 less than Jonfran's current manufacturing cost, which is as follows:

Direct materials				$10
Direct labor				8
Variable overhead				6
Fixed overhead:
Supervision		$2
Facilities		5
General		4		11
Total unit cost				$35

Jonfran uses a plantwide fixed overhead rate in its operations. If the waste containers are purchased outside, the salary and benefits of one supervisor, included in fixed overhead at $45,000, would be eliminated. There would be no other changes in the other cash and noncash items included in fixed overhead except depreciation on the new equipment.

Jonfran is subject to a 25 percent tax rate. Management assumes that all cash flows occur at the end of the year and uses a 12 percent after-tax discount rate.

You must use the Exhibit 19B.1 and Exhibit 19B.2 present value tables and Exhibit 19.5 to solve the following problems.

Required:

1. Prepare a schedule of cash flows for the make alternative. Enter cash outflows as negative amounts and cash inflows as positive amounts. Round your answers to the nearest dollar when rounding is required.

Calculate the NPV of the make alternative. Round intermediate calculations and your final answer to the nearest dollar. If the NPV is negative, enter your answer as a negative value.

2. Prepare a schedule of cash flows for the buy alternative. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Calculate the NPV of the buy alternative. Round intermediate calculations and your final answer to the nearest dollar. If the NPV is negative, enter your answer as a negative value.