ABC Manufacturing expects to sell 1,025 units of product in 2022 at an average price of $100,000 each based on current demand. The Chief Marketing Officer forecasts growth of 50 units per year through 2026. So, the demand will be 1,025 units in 2022, 1,075 units in 2023, etc. and the $100,000 price will remain consistent for all five years of the investment life. However, ABC cannot produce more than 1,000 units annually based on current capacity. In order to meet demand, ABC must either update the current plant or replace it. If the plant is replaced, an initial working capital investment of $6,000,000 is required and these funds will be released at the end of the investment life to be used elsewhere. The following table summarizes the projected data for both options: Update Replace Initial investment in 2022 $ 125,000,000 $ 130,000,000 Terminal salvage value in 2026 $ 8,000,000 $ - Working capital investment required $ - $ 6,000,000 Useful life 5 years 5 years Total annual cash operating costs per unit $ 64,000 $ 63,000 The investment will be made at the beginning of 2022 and all transactions after that are assumed to occur on the last day of each year. ABC's required rate of return is 16%. 3. Calculate the project profitability index (PPI) for both the update and replace alternatives.
ABC Manufacturing expects to sell 1,025 units of product in 2022 at an average price of $100,000 each based on current demand. The Chief Marketing Officer forecasts growth of 50 units per year through 2026. So, the demand will be 1,025 units in 2022, 1,075 units in 2023, etc. and the $100,000 price will remain consistent for all five years of the investment life. However, ABC cannot produce more than 1,000 units annually based on current capacity. In order to meet demand, ABC must either update the current plant or replace it. If the plant is replaced, an initial working capital investment of $6,000,000 is required and these funds will be released at the end of the investment life to be used elsewhere. The following table summarizes the projected data for both options: Update Replace Initial investment in 2022 $ 125,000,000 $ 130,000,000 Terminal salvage value in 2026 $ 8,000,000 $ - Working capital investment required $ - $ 6,000,000 Useful life 5 years 5 years Total annual cash operating costs per unit $ 64,000 $ 63,000 The investment will be made at the beginning of 2022 and all transactions after that are assumed to occur on the last day of each year. ABC's required rate of return is 16%. 3. Calculate the project profitability index (PPI) for both the update and replace alternatives.
Chapter11: Capital Budgeting Decisions
Section: Chapter Questions
Problem 17EB: Caduceus Company is considering the purchase of a new piece of factory equipment that will cost...
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| ABC Manufacturing expects to sell 1,025 units of product in 2022 at an average price of $100,000 each based on current demand. | ||||||
| The Chief Marketing Officer |
||||||
| in 2023, etc. and the $100,000 price will remain consistent for all five years of the investment life. However, ABC cannot produce more | ||||||
| than 1,000 units annually based on current capacity. |
| In order to meet demand, ABC must either update the current plant or replace it. If the plant is replaced, an initial working capital investment | |||||
| of $6,000,000 is required and these funds will be released at the end of the investment life to be used elsewhere. | |||||
| The following table summarizes the projected data for both options: |
| Update | Replace | |||||||
| Initial investment in 2022 | $ 125,000,000 | $ 130,000,000 | ||||||
| Terminal salvage value in 2026 | $ 8,000,000 | $ - | ||||||
| Working capital investment required | $ - | $ 6,000,000 | ||||||
| Useful life | 5 years | 5 years | ||||||
| Total annual cash operating costs per unit | $ 64,000 | $ 63,000 |
| The investment will be made at the beginning of 2022 and all transactions after that are | |
| assumed to occur on the last day of each year. ABC's required |
| 3. Calculate the project profitability index (PPI) for both the update and replace alternatives. |
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