CHAPTER 7

END-OF-CHAPTER PROBLEMS

7.5

7.6

7.7

7.8. Thus,

7.9. Thus,

7.10 /

7.12Design:

Fabrication:

Finishing:

7.15 /

Prefer to build a large line. Large line has a payoff of $200,000. Small line has a payoff of .

7.16(a)Proposal A breakeven in units is:

(b)Proposal B breakeven in units is:

7.17(a)Proposal A breakeven in dollars is:

(b)Proposal B breakeven in dollars is:

7.18Set Proposal A  to Proposal B

7.19(a)Proposal A: Profit at 8,500 units

Proposal A is best.

(b) /
Proposal B is best.

7.20Given:

(a)Breakeven in units is given by:

(b)Breakeven in dollars is given by:

(c)Profit is given by:

7.21Given:

Breakeven is given by:

7.22Given:

Breakeven is given by:

7.23Given:

Breakeven is given by:

(a)

(b)

7.24Option A: Stay as is

Option B: Add new equipment

Therefore, the company should stay with the present equipment.

7.25Option A: Stay as is

Option B: Add new equipment, raise selling price

Therefore, the company should choose option B: add the new equipment and raise the selling price.

7.26 /
Units / Mehra’s / Memphis Supply
0 / 15,000 / 0
10,000 / 33,200 / 40,000

at approximately 7,000 gears

7.27 / Units / 0 / 4000 (arbitrary number)
(A) / 600 / $5000 / refurbish
(B) / 1100 / $3900 / modify
(C) / 1800 / $3400 / new
(a) /

(b)At 3,000, C is best.

(c)Between 1600 and 2400, B is best.

7.31Initial investment = $123,545

Salvage value: $44,560

Five-year return = $14,667

Cost of capital = 12%

NPV annuity factor  5 years @ 12% = 3.605  3.61

Present value = 3.61  14667 = 52948

Present value of salvage: 0.567  44560 = 25266

Net present value = 52948 + 25266 – 123545 = –$45,331

7.32Initial investment = $65,000

Eight-year return = $16,000 per year

Cost of capital = 10%

NPV annuity factor  8 years @ 10% = 5.33

Present value = 5.33  $16000 = $85,280

Net present value = $85,280 – $65,000 = $20,280

7.33

or from Table 7.4

7.34

or from Table 7.4

7.35 / Expense / Machine A / Machine B
Original cost / 10000 / 20000
Labor per year / 2000 / 4000
Maintenance per year / 4000 / 1000
Salvage value / 2000 / 7000
Machine A
Year / NPV Factor* / NPV
Now / Expense / 10000 / 1.000 / – 10000
1 / Expense / 6000 / 0.893 / – 5358
2 / Expense / 6000 / 0.797 / – 4782
3 / Expense / 6000 / 0.712 / – 4272
– 24412
3 / Salvage revenue / 2000 / 0.712 / + 1424
– 22988

*NPV factor from Table 7.4

Machine B
Year / NPV Factor* / NPV
Now / Expense / 20000 / 1.000 / – 20000
1 / Expense / 5000 / 0.893 / – 4465
2 / Expense / 5000 / 0.797 / – 3985
3 / Expense / 5000 / 0.712 / – 3560
–32010
3 / Salvage revenue / 7000 / 0.712 / + 4984
– 27026

*NPV factor from Table 7.4

NPV for machine A is –$22,988; NPV for machine B is –$27,026. Therefore, Machine A should be recommended.

7.36 / Expense / Three Small Ovens / Two Large Ovens
Original cost / 3750 / 5000
Excess labor per year / 750 / 0
Maintenance per year / 750 / 400
Salvage value / 750 / 1000
Three Small Ovens
Year / NPV Factor* / NPV
Now / Expense / 3750 / 1.000 / – 3750
1 / Expense / 1500 / 0.877 / – 1316
2 / Expense / 1500 / 0.769 / – 1154
3 / Expense / 1500 / 0.675 / – 1013
4 / Expense / 1500 / 0.592 / – 888
5 / Expense / 1500 / 0.519 / – 779
– 8900
5 / Salvage revenue / 750 / 0.519 / + 389
– 8511

*NPV factor from Table 7.4

Two Large Ovens
Year / NPV Factor* / NPV
Now / Expense / 5000 / 1.000 / – 5000
1 / Expense / 400 / 0.877 / – 351
2 / Expense / 400 / 0.769 / – 308
3 / Expense / 400 / 0.675 / – 270
4 / Expense / 400 / 0.592 / – 237
5 / Expense / 400 / 0.519 / – 208
– 6374
5 / Salvage revenue / 1000 / 0.519 / + 519
– 5855

*NPV factor from Table 7.4

(a)NPV of the three small ovens = –$8,511; NPV of the two large ovens = –$5,855. Therefore, you should recommend that the firm purchase the two large ovens.

(b)The basic assumptions made with regard to the ovens are:

The ovens are of equal quality

The ovens are of equivalent production capacity

(c)The basic assumptions made with regard to methodology are:

Future interest rates are known

Payments are made at the end of each time period

7.37Investment A net income, using Table 7.5

Investment B Net Income
Year / NPV Factor* / NPV
Now / Expense / 74,000 / 1.000 / – 74,000
1 / Revenue / 19,000 / 0.917 / + 17,423
2 / Revenue / 20,000 / 0.842 / + 16,840
3 / Revenue / 21,000 / 0.772 / + 16,212
4 / Revenue / 22,000 / 0.708 / + 15,576
5 / Revenue / 21,000 / 0.650 / + 13,650
6 / Revenue / 20,000 / 0.596 / + 11,920
7 / Revenue / 11,000 / 0.547 / + 6,017
23,638

*From Table 7.4

Therefore, Investment A, with a payoff of $24,234, would be preferred over Investment B, with a payoff of $23,638.

7.38Initial investment = $ 20,000

Cash Flows
NPV / Cash Flow 1 / Cash Flow 2 / Cash Flow 3
Year / Factor / P / P / P
1 / 0.909 / $1,000 / $ 909 / $ 7,000 / $ 6,363 / $ 10,000 / $ 9,090
2 / 0.826 / 1,000 / 826 / 6,000 / 4,956 / 5,000 / 4,130
3 / 0.751 / 3,000 / 2,253 / 5,000 / 3,755 / 3,000 / 2,253
4 / 0.683 / 15,000 / 10,245 / 4,000 / 2,732 / 2,000 / 1,366
5 / 0.621 / 3,000 / 1,863 / 4,000 / 2,484 / 1,000 / 621
6 / 0.564 / 1,000 / 564 / 4,000 / 2,256 / 1,000 / 564
7 / 0.513 / — / — / 4,000 / 2,052 / 1,000 / 513
8 / 0.467 / 1,000 / 467 / 2,000 / 934 / — / —
9 / 0.424 / — / — / — / — / 1,000 / 425
$17,127 / $25,532 / $18,962

The NPV from investment 2 is highest, at $5,532 (after initial investment of $20,000 is subtracted).

Chapter 7: Process Strategy and Capacity Planning / 1