Question

ASSIGNMENT QUESTIONS

1. Without using any numbers, identify the strengths and weaknesses of the three options identified by French. Are there any other options French should consider?

2. Compute and compare the net present value and payback, period of each option.

3. Make a recommendation for French.

4. Rounding to the nearest 1 %, at what discount rate does leasing produce a higher net present value than paying cash?

Need help with answering question 2 and 4. 

Answer 1

Solution 2 COMPUTATION OF NPV OF THE OPTIONS $50,000 per month Increase in Revenue Company's Margirn 35% $17,500 Increase in Profits Present Value of Company's Increased Profits PVAF(7/12, 5*12) x $17500 for 5 years - $8,83,793.31 OPTION 1 Purchase a new CNC Machine with Cashh $1,42,000 Initial Cost $10,000 per month Operating Costs Time 5 years $40,000 Salvage Value after 5 years discount rate 7.00% PVAF(7/12, 5x12) x $10000 - $5,05,024.75 Present Value of Operating costs PVIF(7/12,5x12) x $40000 -$28,272.36 Present Value of Salvage Value NPV of Option 1 A+C-B-D - $2,65,040.92

OPTION 2 Financing the purchase of a new CNC machine $50,000 Down payment $2,200 Monthly Payments $1 Cost of Equipment after 5 Years $10,000 per month Operating Costs $40,000 Salvage Value after 5 years discount rate 7.00% PVAF(7/12, 5x12) x $2200 Present Value of Monthly Installments - $1,11,105.44 PVAF(7/12, 5x12) x $10000 - $5,05,024.75 Present Value of Operating costs PVIF(7/12, 5x12) x $40000 -$28,272.36 Present Value of Salvage Value E. NPV of Option 2 A+E-B-C-D - $2,45,935.48 OPTION 3 Add a Third Shift $12,000 Additional Monthly Operating costs PVAF(7/12, 5x12) x $12000 - $6,06,029.70 Present Value of Operating costs NPV of Option 3 A-B - $2,77,763.61 OPTIONS NPVs 1st $2,65,040.92 2nd $2,45,935.48 3rd $2,77,763.61

COMPUTATION OF PAYBACK PERIOD Payback period is the time period to recover the initial Investments Option 1 $1,42,000 A. Initial Investments Yearly Increase in Income ($17500 x 12) $2,10,000 Yearly Increase in Expenses $1,20,000 (S10000 x x12) B. Net Increase in profit $90,000 Payback A/B 1.58 years Option 2 A. Initial Investment $50,000 Yearly Increase in Income ($17500 x 12) $2,10,000 Yearly Increase in Expenses $1,46,400 (S12200 x x12) $63,600 B. Net Increase in profit Payback A/B 0.79 years Option 3 No Initial Investment, Hence the payback period is 0 years

The 7% rate is used to discount the Future Inflows and outflows into the present values