The Balboa Bottling Company is contemplating the replacement of one of
its bottling machines with a newer and more efficient one. The old
machine has a book value of $600,000 and a remaining useful life of 5
years. The firm does not expect to realize any return from scrapping the
old machine in 5 year, but it can sell it now to another firm in the
industry for $265,000. The old machine is being depreciated by $120,000
per year, using the straight line method.
The new machine has a purchase price of $1,175,000, an estimated useful
life and MACRS class life of 5 years, and an estimated salvage value of
$145,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%
and 6%. It is expected to economize on electric power usage, labor, and
repair costs, as well as to reduce the number of defective bottles. In
total, an annual savings of $255,000 will be realized if the new machine
is installed. The company's marginal tax rate is 35%, and it has a 12%
WACC.
a) What is the initial net cash flow if the new machine is purchased and the old one is replaced?
b) Calculate the annual depreciation allowances for both machines, and
compute the change in the annual depreciation expense if the replacement
is made.
c) What are the incremental net cash flows in Years 1 through 5?
d) Should the firm purchase the new machine? Support your answer.
e) In general, how would each of the following factors affect the investment decision, and how should each be treated?
(1) The expected life of the existing machine decreases.
(2) The WACC is not constant but is increasing as Balboa adds more projects into its
capital budget for the year.
Click here for the solution: The Balboa Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one
Showing posts with label bottling. Show all posts
Showing posts with label bottling. Show all posts
Friday, September 25, 2015
Wednesday, September 23, 2015
Bair Company is a manufacturer of standard and custom-designed bottling equipment
Bair Company is a manufacturer of standard and custom-designed bottling
equipment. Early in December 20x0 Lyan Company asked Bair to quote a
price for a custom-designed bottling machine to be delivered in April.
Lyan intends to make a decision on the purchase of such a machine by
January 1, so Bair would have the entire first quarter of 20x1 to build
the equipment. Bair’s pricing policy for custom-designed equipment is 50
percent markup on absorption manufacturing cost. Lyan’s specifications
for the equipment have been reviewed by Bair’s Engineering and Cost
Management departments, which made the following estimates for direct
material and direct labor.
Direct material ............................................ $307,200
Direct labor (11,000 hours at $18) .................. 198,000
Manufacturing overhead is applied on the basis of direct-labor hours. Bair normally plans to run
its plant at a level of 15,000 direct-labor hours per month and assigns overhead on the basis of 180,000 direct-labor hours per year. The overhead application rate for 20x1 of $10.80 per hour is based on the following budgeted manufacturing overhead costs for 20x1.
Variable manufacturing overhead ......................... $1,166,400
Fixed manufacturing overhead .............................. 777,600
Total manufacturing overhead ................... $1,944,000
Bair’s production schedule calls for 12,000 direct-labor hours per month during the first quarter. If Bair is awarded the contract for the Lyan equipment, production of one of its standard products would have to be reduced. This is necessary because production levels can only be increased to 15,000 direct labor hours each month on short notice. Furthermore, Bair’s employees are unwilling to work overtime.
Sales of the standard product equal to the reduced production would be lost, but there would be no permanent loss of future sales or customers. The standard product for which the production schedule would be reduced has a unit sales price of $14,400 and the following cost structure.
Direct material ....................................................................... $ 3,000
Direct labor (250 hours at $18) .............................................. 4,500
Manufacturing overhead (250 hours at $10.80) .................. 2,700
Total cost ...................................................................... $10,200
Lyan needs the custom-designed equipment to increase its bottle-making capacity so that it will not have to buy bottles from an outside supplier. Lyan Company requires 5,000,000 bottles annually. Its present equipment has a maximum capacity of 4,500,000 bottles with a directly traceable cash outlay cost of 18 cents per bottle. Thus, Lyan has had to purchase 500,000 bottles from a supplier at 48 cents each. The new equipment would allow Lyan to manufacture its entire annual demand for bottles at a direct-material cost savings of 1.2 cents per bottle. Bair estimates that Lyan’s annual bottle demand will continue to be 5,000,000 bottles over the next five years, the estimated life of the special-purpose equipment.
Required:
Bair Company’s management plans to submit a bid to Lyan Company for the manufacture of the special-purpose bottling equipment.
1. Calculate the bid Bair would submit if it follows its standard pricing policy for special-purpose equipment.
2. Calculate the minimum bid Bair would be willing to submit on the Lyan equipment that would result in the same total contribution margin as planned for the first quarter of 20x1.
3. Suppose Bair has submitted a bid slightly above the minimum calculated in requirement (2). Upon receiving Bair’s bid, Lyan’s assistant purchasing manager telephoned his friend at Tygar Corporation: “Hey Joe, we just got a bid from Bair on some customized equipment. I think Tygar would stand a good chance of beating it. Stop by the house this evening, and I’ll show you the details of Bair’s bid and the specifications on the machine.” Is Lyan Company’s assistant purchasing manager acting ethically? Explain.
Click here for the solution: Bair Company is a manufacturer of standard and custom-designed bottling equipment
Direct material ............................................ $307,200
Direct labor (11,000 hours at $18) .................. 198,000
Manufacturing overhead is applied on the basis of direct-labor hours. Bair normally plans to run
its plant at a level of 15,000 direct-labor hours per month and assigns overhead on the basis of 180,000 direct-labor hours per year. The overhead application rate for 20x1 of $10.80 per hour is based on the following budgeted manufacturing overhead costs for 20x1.
Variable manufacturing overhead ......................... $1,166,400
Fixed manufacturing overhead .............................. 777,600
Total manufacturing overhead ................... $1,944,000
Bair’s production schedule calls for 12,000 direct-labor hours per month during the first quarter. If Bair is awarded the contract for the Lyan equipment, production of one of its standard products would have to be reduced. This is necessary because production levels can only be increased to 15,000 direct labor hours each month on short notice. Furthermore, Bair’s employees are unwilling to work overtime.
Sales of the standard product equal to the reduced production would be lost, but there would be no permanent loss of future sales or customers. The standard product for which the production schedule would be reduced has a unit sales price of $14,400 and the following cost structure.
Direct material ....................................................................... $ 3,000
Direct labor (250 hours at $18) .............................................. 4,500
Manufacturing overhead (250 hours at $10.80) .................. 2,700
Total cost ...................................................................... $10,200
Lyan needs the custom-designed equipment to increase its bottle-making capacity so that it will not have to buy bottles from an outside supplier. Lyan Company requires 5,000,000 bottles annually. Its present equipment has a maximum capacity of 4,500,000 bottles with a directly traceable cash outlay cost of 18 cents per bottle. Thus, Lyan has had to purchase 500,000 bottles from a supplier at 48 cents each. The new equipment would allow Lyan to manufacture its entire annual demand for bottles at a direct-material cost savings of 1.2 cents per bottle. Bair estimates that Lyan’s annual bottle demand will continue to be 5,000,000 bottles over the next five years, the estimated life of the special-purpose equipment.
Required:
Bair Company’s management plans to submit a bid to Lyan Company for the manufacture of the special-purpose bottling equipment.
1. Calculate the bid Bair would submit if it follows its standard pricing policy for special-purpose equipment.
2. Calculate the minimum bid Bair would be willing to submit on the Lyan equipment that would result in the same total contribution margin as planned for the first quarter of 20x1.
3. Suppose Bair has submitted a bid slightly above the minimum calculated in requirement (2). Upon receiving Bair’s bid, Lyan’s assistant purchasing manager telephoned his friend at Tygar Corporation: “Hey Joe, we just got a bid from Bair on some customized equipment. I think Tygar would stand a good chance of beating it. Stop by the house this evening, and I’ll show you the details of Bair’s bid and the specifications on the machine.” Is Lyan Company’s assistant purchasing manager acting ethically? Explain.
Click here for the solution: Bair Company is a manufacturer of standard and custom-designed bottling equipment
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