Your business has recently purchased a new fabrication machine designed to create sellable units.
Market analysis shows that the company can expect to sell 25,000 units per year.
The company uses a MARR of 7% and relevant data is provided for the new machine:
|Cost to make unit||$7.00/unit|
|Selling price per unit||$12.50/unit|
|Annual Maintenance Cost||$100,000|
1. Assuming your business expects to run this project for ten years, how many units need to be created per year by the machine to be profitable? Use PW analysis.
2. Given the expected sale of 25,000 units per year, will this machine be profitable within this ten-year time frame?
3. Assuming 25,000 units made/sold per year, in what year will the project reach a break-even point?
(Round to whole year)
4. Assuming 25,000 units made/sold per year, what selling price would provide the company exactly the MARR?
(if the venture is unprofitable, how high do they need to raise the selling price; if profitable, how low could they sell the units while still making their MARR)
Net present value
To evaluate the profitability of a long term project, its absolute cash flows are not accurately the value it is today. This is because a $1 today does not worth the same in the future. It might be of a lower value due to inflation and other factors. This is a principle called the time value of money. Hence, the cash flows from a project needs to be discounted using the Minimum Acceptable Rate of Return (MARR) or also known as the hurdle rate, or the minimum rate a company expects to receive as a return from the project. The entire process of discounting cash inflows and deducting it from the cash outflows in order to know the profitability of a project is a capital budgeting technique called net present value (NPV) method. A positive NPV would mean that a project is profitable because it yields a higher cash inflow than the outflow; a negative NPV indicates otherwise.
Answer and Explanation: 1
Requirement 1: Assuming your business expects to run this project for ten years, how many units need to be created per year by the machine to be...
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fromChapter 5 / Lesson 20
Learn about what net present value is, how it is calculated both for a lump sum and for a stream of income over multiple years. View some examples on NPV.