Mars nco orated is interested in going to market with a new

Mars nco orated is interested in going to market with a new uel sa ngs de ce hat attaches to electrica y powered industrial vehicles. The device, code named \"Python promises to save up to 15% o the electrical power required to operate the average electric forklift. Mars expects that modest demand expected during the introductory year will be followed by a steady increase in demand in subsequent years. The extent of this increase in demand will be based on customer\'s expectations regarding the future cost of electricity, which is shown in Table 1. Mars expects to sell the device for S300 each, and does not expect to be able to raise its price over the foreseeable future Mars is faced with two alternatives: Altemative 1: Make the device themselves, which requires an initial outlay of $550,000 in plant and equipment and a variable cost of $160 per unit. Altemative 2: Outsource the production, which requires no initial investment, but incurs a per unit cost of $175. Click the icon to view Table 1 Assuming small increases in the costo electrical power, compute he cash flows for each alternative. Over the next 5 years, which alternative maximizes the NP o this project if the discount rate is 15%? Determine cash flows for alternative 1 and fill in the table below. (Enter your responses as whole numbers. Be sure to include a minus sign for cash outflows.) Demand in Cash inflow (outflow) Year devices 1,000 5,000 10,000 15,000 18,000

Solution

Case of alternative 1 :

Since initial outlay is $550,000 in plant and equipment, there is a cash outflow of $550,000 in year 0

Net inflow for subsequent years per unit = sale price/ unit – variable cost / unit = $ 300 - $160 = $140 / unit

Inflow for any year = $140/unit x Number of units.

Therefore,

Inflow for year 1 = 140 x 1000 = $140,000

Inflow for year 2 = 140 x 5000 = $700,000

Inflow for year 3 = 140 x 10,000 = $1400,000

Inflow for year 4 = 140 x 15,000 = $2100,000

Inflow for year 5 = 140 x 18,000 = $2520,000

Year

Demand in devices

Cash inflow ( Outflow )

0

-$550,000

1

1000

$140,000

2

5000

$700,000

3

10000

$1400,000

4

15000

$2100,000

5

18000

$2520,000

NPV of the project , $

= - 550,000 + 140,000 / ( 1 + 15/100) + 700,000/( 1 + 15/100)^2 + 1400,000 / ( 1 + 15/100)^3 + 2100,000/( 1 + 15/100)^4 + 2520,000/( 1 + 15/100)^5

= - 550,000 + 121739.13 + 529300.56 + 920522.72 + 1200681.81 + 1252885.37

= $3475129.59

NPV OF THE PROJECT AT A DISCOUNT RATE OF 15% IS $3475129.59

Case for alternative 2 :

Since there is no initial outlay , cash inflow/outflow in year 0 will be NIL

Net inflow for subsequent years per unit = sale price/ unit – variable cost / unit = $ 300 - $175 = $125 / unit

Inflow for any year = $125/unit x Number of units.

Therefore,

Inflow for year 1 = 125 x 1000 = 125,000

Inflow for year 2 = 125 x 8000 = 1000,000

Inflow for year 3 = 125 x 15000 = 1875,000

Inflow for year 4 = 125 x 20,000 = 2500,000

Inflow for year 5 = 125 x 30,000 = 3750,000

Year

Demand in devices

Cash inflow ( Outflow )

0

0

1

1000

$125,000

2

8000

$1000,000

3

15000

$1875,000

4

20000

$2500,000

5

30000

$3750,000

NPV of the project , $

= 125000/ ( 1 + 15/100) + 1000,000/ ( 1 + 15/100)^2 + 1875,000/ ( 1 + 15/100)^3 + 2500,000/ ( 1 + 15/100)^4 + 3750,000/( 1 + 15/100)^5

= 108695.65 + 756143.66 + 1232842.93 + 1429383.11 + 1864412.75

= 5391478.10

NPV OF THE PROJECT AT A DISCOUNT RATE OF 15% IS $5391478.10

ALTERNATIVE 2 MAXIMIZES NPV OF THE PROJECT

Year	Demand in devices	Cash inflow ( Outflow )
0		-$550,000
1	1000	$140,000
2	5000	$700,000
3	10000	$1400,000
4	15000	$2100,000
5	18000	$2520,000