Svens Component

Sven Nys is a divisional manager of Vandelay Industries. Sven is considering introducing a new component to the existing product line. Introducing the new component would require the purchase of new equipment. The equipment would cost $170,000, last for 2 years, and have zero salvage value at the end of the two years. Sven estimates that the variable overhead associated with the new component will be $95,000 a year and is allocated based on direct labor dollars. The new product will also require hiring a new employee at an annual wage of $30,000/year. This employee manufactures the new component. The new component consumes $20/unit of direct materials. The production volume, sales, and marketing costs for this new product line in each of the two years that the new component would be produced are as follows:

Year	2012	2013
Production (units)	1,800	1,700
Sales (units)	1,200	2,300
Selling Price/u	$150	$150
Marketing Cost	$10,000	$10,000

Vandelay Industries uses full absorption for both book and tax purposes. It is company policy that straight-line depreciation is used for all production machinery, and that fixed overhead is allocated on the basis of units produced. Vandelay Industries uses LIFO (last in, first out) inventory flow assumption. Vandelay Industries uses a 12% discount rate for all net present value calculations and faces a tax rate of 30% of net income. Van delay industries has positive income elsewhere in the business, so the taxes associated with any losses result in cash saved.

The company must pay for the machine in cash upon delivery. For purposes of the analysis, assume that that all other expenses associated with producing the new component will be paid in cash at the end of the year in which they occur. Also, assume that all sales of the new component will be received in cash at the end of the year in which they occur. Assume that all units produced in the year are complete and ending balance of WIP is 0.

Svens compensation is a base salary (regardless of wether the firm takes the project) plus a bonus of 10% of after-tax income, which is paid in cash at the end of the year. When considering the bonus scheme, the firm includes 30% of any loss as a reduction in the loss (e.g. a net income of -$100 results in an after-tax net income of -$70 and a "bonus" for SVEN of $-7). Please ignore the bonus when calculating the net income below and the net present value of the component from the firm's perspective below.

1. What would happen to the NPV of the project from the perspective of Vandelay Industries if they leased the equipment for $85,000 a year making those lease payments at the end of each year? (Assume all other facts remain the same).

a. the npv of the project would increase b. the npv of the project would decrease c. the npv of the project would remain the same

2.What would happen to the net income over the two-year life of the project from the perspective of Vandelay Industries if they leased the equipment for $85,000 a year making those lease payments at the end of each year? (Assume all other facts remain the same).

a. net income would not change b. net income would increase c. net income would decrease