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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,Hello sir,
in the above 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.I understand the variable cost after the project is being used. But I don’t understand why a sales vale of $6 is used when the first line clearly says the selling price per unit is $12, and no more comments are made on this.
Also for there was a blank space in the question to fill the sales proceeds for year 5.
The answer to the sales proceeds was $60,000. Isn’t that the amount received when reselling the investment. Aren’t Sales proceeds just normal Sales value for a month which i think would be 50,000 units * $12 = $600,000.PLs requesting for help for explanation of the above 2 queries.
thank you
kindly,
Sukaina.The contribution is not $1.50 per unit.
$1.50 is the extra contribution that will be earned per unit if they install the new technology, and it is this that is relevant when deciding whether or not the new technology should be installed.
The $60,000 is the proceeds from the sale of the new technology at the end of 5 years.
(The revenue from the sales of hairdryers each year is not relevant because the proceeds each year will be the same whether or not the new technology is installed.)
Thank you sir,
I now understand the extra contribution and the fact that 60,000 is the only relevant inflows at the moment.
just wanted to ask if a cash inflow and outflow statement is made for the new technology, for years 1 to 4 we wont keep and cash inflows from sales proceeds as they are irrelevant right? only in the final year we keep the proceeds from the disposal.That is correct. It is only the extra cash flows coming from the new technology that are relevant.
🙂Sir i calculated net cash flows please correct me if I’m wrong
Cash flows per year 50000 cost of capital 10% present value of cash flows =189539
Cost =250,000-189539=60461
Npv is still negative, or did i do something wrong sir?
The cash inflow each year is 75,000 less the extra fixed costs. In addition there are the sale proceeds from the technology at the end of the 5th year.
Do not ask me to provide a full answer. I will explain problems people have with regard to answers in their Revision Kits (as I did to the original post), but I do not have the time to prepare full answers to full questions (and that is not what our forums are here for).
No sir i didn’t ask for any other answer just net cash flow, as with the other figures I’m clear about them, but I can’t figure out net cash flow but I’ve tried it again because it asks to calculate npv of the new technology so I’ve done it like this
75000 cash inflows each year so for the 5 years 75000×3.791= 284325 less fixed cost each year will be 15k for the 5 years it will be 75000
209325 and then adding the sale proceeds at the end 60000=269325 but that is present value sir? New technology costs $250000 we are going to deduct that from this value to get net present value?
Answer 19325 npv positive, am i right sir?
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