Beacon Company is considering automating its production facility. The initial investment in automation would be $15 million, and the equipment has a useful life of 10 years with a residual value of $500,000. The company will use straight-line depreciation. Beacon could expect a production increase of 40,000 units per year and a reduction of 20 percent in the labor cost per unit.
.:.
Required:
1. Complete the preceding table showing the totals and summarize the difference in the alternatives.
2. Determine the project’s accounting rate of return.
3. Determine the project’s payback period.
4. Using a discount rate of 15 percent, calculate the net present value (NPV) of the proposed investment.
5. Recalculate the NPV using a 10 percent discount rate.
6. Would you advise Beacon to invest in the automation?
SOLUTION:
Req. 1
| Current (No Automation) | Current (No Automation) | Proposed (Automation) | Proposed (Automation) | |
|---|---|---|---|---|
| Production and Sales Volume | 80,000 units | 80,000 units | 120,000 units | 120,000 units |
| Per Unit | Total | Per Unit | Total | |
| Sales Revenue | $90 | $7,200,000 | $90 | $10,800,000 |
| Variable Costs: | ||||
| Direct Materials | $18 | $18 | ||
| Direct Labor | 25 | 20 | ||
| Variable Manufacturing Overhead | 10 | 10 | ||
| Total Variable Manufacturing Costs | 53 | 48 | ||
| Contribution Margin | $37 | 2,960,000 | $42 | 5,040,000 |
| Fixed Manufacturing Costs | 1,250,000 | 2,350,000 | ||
| Net Income | $1,710,000 | $2,690,000 |
Automation would generate a total increase in net income of $980,000.
Req. 2
Accounting Rate of Return = Annual Net Income / Initial Investment
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