A company wants to buy a labor-saving piece of equipment. Using the NPV method of capital budgeting, determine the proposal's appropriateness and economic viability with the following information:
Labor content is 12% of sales, which are annually $10 million.
The new equipment will save 20% of labor annually.
The new equipment will last 5 years.
The new equipment will cost $200,000.
The discount rate is 10%
I have this same problem. I just cannot figure out if the labor content is needed to calculate the NPV. Any ideas?
NPV method of capital budgeting, determine the proposal’s appropriateness and economic viability with the following information:
• The new program will increase current sales, $10 million, by 20%.
• The new program will have a profit margin is 5% of sales.
• The new program will have a 3-year effect.
• The new program will cost the company $200,000 in the first year.
To determine the proposal's appropriateness and economic viability using the NPV (Net Present Value) method of capital budgeting, we need to calculate the NPV of the project.
Here are the steps to calculate the NPV:
Step 1: Calculate the annual savings in labor costs.
Labor costs are currently 12% of sales, which amount to $10 million annually. Therefore, the labor cost is 0.12 * $10 million = $1.2 million per year.
The new equipment will save 20% of labor costs annually. So, the annual savings in labor costs will be 0.2 * $1.2 million = $240,000 per year.
Step 2: Determine the cash flows over the equipment's useful life.
Since the new equipment will last for 5 years, we need to consider the annual savings in labor costs over this period.
Year 1: $240,000
Year 2: $240,000
Year 3: $240,000
Year 4: $240,000
Year 5: $240,000
Step 3: Calculate the Present Value (PV) of the cash flows.
To calculate the PV of the cash flows, we need to discount them using the discount rate of 10%.
PV = Year 1 / (1 + discount rate)^1 + Year 2 / (1 + discount rate)^2 + Year 3 / (1 + discount rate)^3 + Year 4 / (1 + discount rate)^4 + Year 5 / (1 + discount rate)^5
PV = $240,000 / (1 + 0.1)^1 + $240,000 / (1 + 0.1)^2 + $240,000 / (1 + 0.1)^3 + $240,000 / (1 + 0.1)^4 + $240,000 / (1 + 0.1)^5
Step 4: Calculate the initial investment.
The cost of the new equipment is given as $200,000.
Step 5: Calculate the NPV.
NPV = PV - Initial Investment
Now, substitute the values into the equation:
NPV = PV - Initial Investment
= [calculate the PV using the discount rate] - $200,000
If the calculated NPV is positive, it indicates that the proposal is economically viable. If the NPV is negative, it suggests that the proposal is not economically viable.
So, plug in the calculated values and compute the NPV.