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ABC Manufacturing expects to sell 1,025 units of product in 2021 at an average price of $100,000 each based on current demand

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ABC Manufacturing expects to sell 1,025 units of product in 2021 at an average price of $100,000 each based on current demand. 

The Chief Marketing Officer forecasts growth of 50 units per year through 2025. So, the demand will be 1,025 units in 2021, 1,075 units

 

in 2022, etc. and the $100,000 price will remain consistent for all five years of the investment life. However, ABC cannot produce more 

 

than 1,000 units annually based on current capacity. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In order to meet demand, ABC must either update the current plant or replace it. If the plant is replaced, an initial working capital investment

 

 of $5,000,000 is required and these funds will be released at the end of the investment life to be used elsewhere. 

 

 

 

The following table summarizes the projected data for both options:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Update

 

Replace

 

 

 

Initial investment in 2021

 

 

 

 $  115,000,000 

 

 $  138,000,000 

 

 

 

Terminal salvage value in 2025

 

 

 

 $   10,000,000 

 

 $           -  

 

 

 

Working capital investment required

 

 

 $           -  

 

 $    5,000,000 

 

 

 

Useful life

 

 

 

 

 

5 years

 

5 years

 

 

 

Total annual cash operating costs per unit

 

 

 $       70,000 

 

 $       60,000 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The investment will be made at the beginning of 2021 and all transactions after that are 

 

 

 

 

assumed to occur on the last day of each year. ABC's required rate of return is 14%. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Required: [Please refer to the two Excel video lectures posted on Blackboard for Ch. 13 when setting up your spreadsheet for

 

 

guidance. You may set up your spreadsheet using this file (on a separate Excel worksheet) to address requirement #1, #2, and #3 and then 

 

answer question #4 directly on the spreadsheet. There are multiple ways to set up your spreadsheet and part of the exercise is each 

 

student setting up his/her own spreadsheet.]

 

 

 

 

 

 

 

 

1. Using Excel functions (NPV and/or PV functions) and formulas, calculate the net present value (NPV) for both the update and replace alternatives.

2. Using Excel functions (IRR function) and formulas, calculate the internal rate of return (IRR) for both the update and replace alternatives.

3. Calculate the project profitability index (PPI) for both the update and replace alternatives.

 

 

 

 

4. Based on the results, which option should ABC choose? Specifically explain why.