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John Moffat.
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- January 21, 2022 at 7:43 pm #647233
Great Southern Co manufactures hairdryers for the hotel industry, which it sells for $12 each. Variable
costs of production are currently $6 per unit. New production technology is now available which would
cost $250,000, but which could be used to make the hairdryers for a variable cost of only $4.50 per
unit.
Fixed costs are expected to increase by $20,000 per year, 75% of which will be directly as a result of
installing the new technology. Great Southern charges depreciation at 20% and seeks a return on its
investments of at least 10%.
The new technology would have an expected life of 5 years and a resale value after that time of
$60,000. Sales of hairdryers are estimated to be 50,000 units per year.
The management accountant has started preparing a spreadsheet to calculate the NPV of the project,In Question the sales contribution was asked to be calculated.
The answer was given as $6- $4.5 = $1.5
$1.5* 50,000 units= $75000.Why it is calculating benefiting extra contribution (6-4.5=1.5) instead of contribution after project which is 12-4.5= 7.5)? It is saying contribution after project so how can we get that it is either asking for benefiting extra contribution or the real contribution which is Sales – Marginal cost.
January 22, 2022 at 10:06 am #647256The spreadsheet is being used to calculate whether or not the project is worthwhile. It will be worthwhile if the NPV of the extra cash flows is positive – they are considering spending $250,000 and need to know if the extra contribution (less the extra fixed costs) justifies spending the $250,000.
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