Question

1. The management of Burrow Mfg. would like to purchase a specialized production machine for $95,000. The machine is expected to last three years, with a salvage value of $5,000. Annual maintenance costs will total $12,000, and annual labor and material savings are predicted to be $55,000. The company's required rate of return in 15%. Find the NPV of this investment.

		$4,404
		$9,564
		$5,623
		$6,466

2. Tina's Manufacturing Company currently makes 100 units of a necessary component. Management is considering outsourcing this component for a cost of $1,200 per unit. Tina's incurs the following total production costs:

Direct Materials	$80,000
Direct Labor	13,000
Variable Overhead	40,000
Fixed Overhead	27,000

If production is outsourced, none of the fixed overhead costs will be eliminated. How would profits be impacted if Tina's bought the component?

		Profits would go down by $40,000
		Profits would go up by $27,000
		Profits would go up by $40,000
		Profits would go up by $13,000

Answer 1

1.	Years	Cashflows	Present value @15%
	0	-95000	-$95,000
	1	43000	$37,391	(43000/1.15^1)
	2	43000	$32,514	(43000/1.15^2)
	3	48000	$31,561	(48000/1.15^3)
		NPV	$6,466
2.	Direct material cost		$80,000
	Direct labor cost		$13,000
	Variable overhead		$40,000
	Fixed Cost		$27,000
	Total relevant cost		$160,000
	Cost of outsource		$120,000
	Add: fixed cost		$27,000
			$147,000
	Savings	=	$13,000	(160000-147000)
	Hence, profit would go up by $13,000

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