The company is considering the purchase of machinery and equipment to set up a line to produce a combination washer-dryer. They have given you the following information to analyze the project on a 5-year timeline: Initial cash outlay is $150,000, no residual value.
Sales price is expected to be $2,250 per unit, with $595 per unit in labor expense and $795 per unit in materials.
Direct fixed costs are estimated to run $20,750 per month.
Cost of capital is 8%, and the required rate of return is 10%.
They will incur all operational costs in Year 1, though sales are expected to be 55% of break-even.
Break-even (considering only direct fixed costs) is expected to occur in Year 2.
Variable costs will increase 2% each year, starting in Year 3.
Sales are estimated to grow by 10%, 15%, and 20% for years 3 - 5.
Then to calculate:
The product’s contribution margin
Break-even quantity
NPV
IRR
Finally:
Explain how the project analyses do or do not support this decision.
In either case, what are the factors that should have been considered in management’s decision?

Break-even quantity = 290 units

NPV = -$150,038.78  

IRR = -12.07%

This project should be rejected because it has a negative NPV and IRR. You would not be able to even recover your own investment, the sales output is too small.

Explanation:

initial outlay -$150,000

selling price per unit $2,250

production costs:

total fixed costs $20,750

contribution margin per unit = $2,250 - ($595 + $795) = $860

contribution margin year 3 = $2,250 - $1,417.80 = $832.20

contribution margin year 4 = $2,250 - $1,446.16 = $803.84

contribution margin year 4 = $2,250 - $1,475.08 = $774.92

in order to calculate the break even point in units we must determine the total fixed costs per year = $20,750 x 12 = $249,000

break even point in units = $249,000 / $860 = 289.5 ≈ 290 units

sales during first year = 290 x 55% = 159.5 ≈ 160 units

sales during second year = 290 units

sales during third year = 290 x 1.1 = 319 units

sales during fourth year = 319 x 1.15 = 366.85 ≈ 367 units

sales during fifth year = 367 x 1.2 = 440.4 ≈ 440 units

net cash flow year 1 = $137,600 - $249,000 = -$111,400

net cash flow year 2 = $249,400 - $249,000 = $400

net cash flow year 3 = $265,471.80 - $249,000 = $16,471.80

net cash flow year 4 = $295,009.28 - $249,000 = $46,009.28

net cash flow year 5 = $340,964.80 - $249,000 = $91,964.80

using a financial calculator and a 10% discount rate, NPV = -$150,038.78  and IRR = -12.07%

In this exercise we have to use finance knowledge to calculate the quantity and taxes calculated on the product, so we have to:

1)  

2) This project should be rejected because it has a negative NPV and IRR. You would not be able to even recover your own investment, the sales output is too small.

Given the values in the text of:

Now calculating the margin for each unit we find that:

Knowing that break even point in units it is worth it 290, we have to:  

So to calculate the net cash we found that:

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