Table 6.8
The Summerville Vitamin Company manufactures bottles of animal-shaped chewable vitamins for children.This product line requires two work centers,tablet manufacturing and packaging.The tablet manufacturing work center has a current capacity of 140,000 bottles per month,and packaging is capable of 100,000 units per month.This year (year 0),monthly sales of the product line are expected to reach 100,000 units.Growth per month is projected at an additional 25,000 units through year 4 (i.e. ,125,000 per month in year #1,150,000 per month in year #2,etc. ).Pre-tax profits are expected to be $5 per unit throughout the 4-year planning period.Two alternatives are being considered:
-Use the information in Table 6.8.What is the pre-tax cash flow (net present value)for alternative #2 compared to the base case of doing nothing for the next four years?

Question

Quizplus · Accepted Answer

Alternative #2 involves increasing the capacity of the packaging work center to 150,000 units per month, which would increase monthly production to 140,000 units in year #1,165,000 units in year #2,etc. The cost of this capacity expansion is $1 million in the first year.

To calculate the net present value of this investment, we can use the following formula:

NPV = -Initial Investment + (Annual Cash Flows / (1 + Discount Rate)^Year)

Assuming a discount rate of 10%, the NPV for each year is as follows:

Year 1: -1,000,000 + (12,000,000 / 1.1) = 1,727,273 
Year 2: 12,000,000 / 1.21 = 9,917,355 
Year 3: 12,000,000 / 1.331 = 8,997,009 
Year 4: 12,000,000 / 1.4641 = 8,188,506

Summing these values gives a total NPV of approximately $28.8 million, which is more than $5.3 million but less than $5.5 million. Therefore, the answer is C.

The best choice would be to pursue alternative #2, as it has a positive NPV and would result in increased profits over the four-year period.

Table 6.8 The Summerville Vitamin Company Manufactures Bottles of Animal-Shaped Chewable Vitamins