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 is the net-present value of introducing the new component from Svens perspective? (Please indicate a negative with a dash "-") Remember that Sven is paid a bonus of 10% of after-tax net income and Sven is interested in only in his cash compensation over 2012 and 2013. Also, assume that Sven's discount rate is 12% and his total compensation declines by 10% of after-tax net income if the net income is negative.

2.Is it in the best interest of Sven to take the project? YES or NO

3. Would Sven take the project if he was required to produce only the units that would be sold? That is, would the NPV of the project from Sven's perspective be positive if production was equal to sales?