Question

Can you please solve P16-40?

1. Cons All applicable Problems are available with McGraw-Hills Connect Accounting connect Anid ing 2. Equ Star Problems Problem 16-40 Net Present Value; Outsourcing Section 1) (LO 16-1, 16-3) 2. Outsource, net present Value: 185,138,400) 4 Othe Community Challenges, a nonprofit organization for physically and mentally challenged people, manu- factures a variety of products in four plants located in California. The company is currently purchasing an electronic igniter from an outside supplier for $62 per unit . Because of supplier reliability problems, the company is considering producing the igniters internally in a currently idle manufacturing plant. Annual volume over the next five years is expected to total 400,000 units at variable manufacturing costs of $60 per unit. Management must hire a factory supervisor and assistant for a total annual salary and fringe benefit package of $95.000 In addition, the company must acquire $60,000 of new equipment. The equipment has a five-year service life and a $12,000 salvage value, and will be depreciated by the straight-line method. Repairs and maintenance are expected to average $4,500 per year in years 3-5, and the equipment will be sold at the end of its life. 5. Opc per 6 The the 7. A wil & Du aft 9. The 10. Th Required: 1. Should discounted cash flows be used in this outsourcing decision? Why? 2. Ignoring your answer to requirement (1), use the net-present-value method (total-cost approach) and a 14 percent hurdle rate to determine whether management should manufacture or outsource the igniters. 3. Suppose management is able to negotiate a lower purchase price from its supplier. At what purchase price would management be financially indifferent between manufacturing and outsourcing the igniters? Sequire 1. Co 2 Pr Problem 16-41 Net Present Value: Total-Cost Approach (Section 1) (LO 16-1, 16-3) Medical Arts Hospital's board of Trustees is considering the addition of a comprehensive medical cente ing laboratory. In the past, the hospital has sent all blood and tissue specimens to Diagnostic Testing Services, an independent testing SI 5. due to

Answer 1

1.                  Yes.  This is a long-term decision, with cash flows that occur over a five-year period.  Given that the cash flows have a “value” dependent on when they take place (e.g., cash inflows that occur in earlier years have a higher time value than cash inflows that take place in later years), discounting should be used to determine whether Community Challenges should outsource.

2.         Community Challenges is better off to manufacture the igniters.

Outsource:
Annual purchase (400,000 units x $62)……………….	$(24,800,000)
Annuity discount factor (Table IV*: r = .14, n = 5)…	x          3.433
Net present value ……………………………………	$(85,138,400)
Manufacture in-house:
Annual variable manufacturing costs (400,000 units x $60)……………………………………………	$(24,000,000)
Annual salary and fringe benefits………………….	(95,000)
Total annual cash flow………………………….	$(24,095,000)
Annuity discount factor (Table IV: r = .14, n = 5)…	x          3.433
Present value of annual cash flows…………..…….	$(82,718,135)
New equipment (time 0)……………………………	(60,000)
Repairs and maintenance: $4,500 x (3.433 - 1.647) (Table IV: r = .14, n = 3-5) ……………………	(8,037)
Equipment sale: $12,000 x .519 (Table III: r = .14,       n = 5)………………………………………….	6,228
Net present value………………………..………..	$(82,779,944)

                        *Discount factors from the tables in Appendix A.

3.         The company would be financially indifferent if the net present value (NPV) of the manufacture alternative equals the NPV of the outsource alternative.  Thus:

                        Let X = purchase price

                        3.433 x 400,000X = $82,779,944

                        1,373,200X = $82,779,944

                        X = $60.28 (rounded)