Problem 17A Question Help Mars ncorporated is interested in going o market with
ID: 416980 • Letter: P
Question
Problem 17A Question Help Mars ncorporated is interested in going o market with new el s v ngs device h st aches o electrical y powered indus el vehicles. The device, code named yt on promises o save up to 5% o he electrical power requred o opera e he avera electr or ift Mars expects ha modes demand ex ecled during the introductory ear will be wed by a steady ricrease in dem and in subsequent years. T e exten o this increase in demand wl be based on customers expecta ons regarding he uture cost of ekctricity, which is shown in Tat1. Mars cxpccts o scll the device for $300 cach, and does not expect to be able to raise ls price ovcr the foresecabc futurc Mars is faced with two altenatves: variable cost of $135 per unit Atemetive 1: Make the device themseves, which requires an initial outlay of $500,000 in plant and equipment and a > Alternative 2, Outsource the production, which requires no initial investment but incurs per unit cost of $150. Click the icon to view Table 1 ssuming sirlal iri eases n lhe co t ure ec nual power o m ute he cash ows for each alle naive C ve' the next 5 years, which a elmalive maxim Les the NPV othis prole if he disu urt rales 14%? Determine cash flows for altenative 1 and fill in the table below (Enter your reaponses as whoie numbera Be sure to iocluoe a minus sign for cash outlows.) Demand in devices Cash Infow (outflow) Year 100D 5,000 0,000 15.000 3,000Explanation / Answer
Cash flow details of the device code named “Python” :
Alternative 1 : Make the device inhouse :
Contribution margin for each device = Price/ unit – Cost / unit = $ 300 / unit - $135/ unit = $165 / unit
Initial outlay i.e. cash outflow in year 0 = $500,000
Cash inflow in any year = Contribution margin/ device x Demand of devices = $165x Demand
Year
Demand in device
Cash inflow
( outflow)
0
-500,000
1
1000
+ 165,000
2
5000
+ 825,000
3
10000
+1650,000
4
15000
+2475,000
5
18000
+2970,000
NPV at discount rate of 14%
= - 500,000 + 165,000/1.14 + 825,000/(1.14)^2 + 1650,000/( 1.14)^3 + 2475,000 / ( 1.14)^4 + 2970,000/(1.14)^5
= - 500,000 + 144736.84 + 634810.71 + 1113703 + 1465398.68 + 1542524.93
= $440,1174.16
Alternative 2 : Outsource the production:
Contribution margin for each device = Price/ unit – Cost / unit = $ 300 / unit - $150/ unit = $150/ unit
Initial outlay i.e. cash outflow in year 0 = NIL
Cash inflow in any year = Contribution margin/ device x Demand of devices = $150x Demand
Year
Demand in device
Cash inflow
( outflow)
0
NIL
1
1000
+ 150,000
2
5000
+ 750,000
3
10000
+1500,000
4
15000
+2250,000
5
18000
+2700,000
NPV at discount rate of 14%
= 150,000/1.14 + 750,000/(1.14)^2 + 1500,000/( 1.14)^3 + 2250,000/( 1.14)^4 + 2700,000/(1.14)^5
= 131578.94 + 577100.64 + 1012457.27 + 1332180.62 + 1402295.39
= $ 4455612.86
Since , NPV of Alternative 2 ( $4455612.86) > NPV of alternative 1 ( $4401174.16) , Alternative 2 maximizes NPV of the project
ALTERNATIVE 2 MAXIMIZES NPV OF THE PROJECT
Year
Demand in device
Cash inflow
( outflow)
0
-500,000
1
1000
+ 165,000
2
5000
+ 825,000
3
10000
+1650,000
4
15000
+2475,000
5
18000
+2970,000