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Sir, this is a question from Kalpan Exam kit Section A – Q85 & Pg 23. What value should be considered for the 2 years: Labour savings would be $9,000 in the first year and labour rates in the second year will increase by 10%. I am unable to understand the calculation as per the suggested answers.
In future, if you want me to answer you must ask in the Ask the Tutor Forum. This forum is for students to help each other.
However I am unable to help you with this question because I do not have the Kaplan Exam Kit (I only have the BPP Revision Kit).
Since it seems to be testing you on inflation, I assume that you have watched my free lectures on investment appraisal with inflation?
LCH manufactures product X which it sells for $5 per unit. Variable costs of production are currently $3 per unit. Sales of product X are estimated to be 75,000 units p.a.
A new machine is available which would cost $90,000 but which could be used to make product X for a variable cost of $2.50 per unit. Fixed costs, however, would increase by $7,500 per annum as a direct result of purchasing the machine.
The machine would have an expected life of 4 years and a disposal value of $10,000. LCH expects to earn at least 12% per annum from its investments. Calculate NPV.Sol. Savings are 75,000 x ($3 – $2.50) – $37,500 p.a. and after deducting Fixed cost of $7,500, the net operating flow is $30,000 for the year.
Sir, can you please tell me why are we only considering the Variable cost and not the Sale value as well to calculate NPV as it is a crucial part of the calculation.
Thanks in advance.
You have obviously not bothered to read my previous reply – if you want for me to answer then you must ask in the Ask the Tutor Forum.
Given that the sales revenue will not change as a result of buying the new machine, it is not crucial to the calculation!! All that is crucial is the affect that the decision will have on the cash flows.
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