Ignore income taxes in this problem.) A newly developed device is being consider
ID: 2477339 • Letter: I
Question
Ignore income taxes in this problem.) A newly developed device is being considered by Fairway Foods for use in processing and canning peaches. The device, which is available only on a royalty basis, is reported to be a great labor saver. Fairway's production manager has gathered the following data: Present labor method Proposed royalty method Per year: Labor cost $ 40,000 $ 5,000 Royalty cost $ 20,000 Initial startup costs associated with the new device $ 100,000 The new device must be obtained through a licensing arrangement with the developer. The license period lasts for only 8 years. Fairway Foods' required rate of return is 10%. Required: a. By use of the incremental cost approach, compute the net present value of the proposed licensing of the new device. Should the company enter into a licensing arrangement to use the new device?Explanation / Answer
Intial investment = $ 100,000
Net savings per year = $40,000 - $25,000
=$15,000
number of years that it will lasts = 8
Discounted Savings for 8 years at 10% annuity = $15000* 5.3349
=$80,023
Net present value = Disc.cash flow - Intial investment
= $80,023 - $100,000
=$19,977
Decision
The company should not enter into the arrangment of new device because it reflects a negtive NPV
=