Contemporary Engineering Economics 6th Edition by Chan Park

تمرين 14

Let's reconsider Problem. Carrier Corporation, a market leader of air conditioning units, is gearing up to push new energy-efficient systems in the wake of the energy bill passed by Congress. Carrier Corporation says it has invested $8 million in developing new heat exchangers- -a major component in air-conditioners-that use less energy and are about 20% smaller and 30% lighter than current energy saving versions. Carrier's current energy-efficient models are almost double the size of its regular central air-conditioning units. The company speculates this model's bulk may have been a deterrent for homeowners. The new air conditioners are expected to hit the market in the second quarter of 2016. Cooling efficiency is measured by a standard called SEER: Seasonal Energy Efficiency Ratio. It's similar to the gas mileage system used on cars-the higher the number, the more money you save. Older systems had SEER numbers as low as 8; the new Carrier systems are rated at 18! (Federal standards will require a minimum SEER of 13 from January 2006). Translated into operating costs, this means that for every $100 you used to spend on electricity for cooling, you now can spend just $39.
Problem
Appliance makers are gearing up to push new energy-efficient systems in the wake of an energy bill that offers tax credits to homeowners who upgrade to electricity-saving appliances. In air conditioning, industry giant Carrier Corporation says it has invested $250 million in developing new heat exchangers-a major component in air-conditioners-that use less energy and are about 20% smaller and 30% lighter than current energy-saving versions. Carrier's current energy-efficient models are almost double the size of its regular central air-conditioning units. The company speculates that this model's bulk may have been a deterrent for homeowners. The new air conditioners were expected to hit the market in the first quarter of 2015.
Cooling efficiency is measured by a standard called SEER: Seasonal Energy Efficiency Ratio. It's similar to the gas mileage system used on cars- the higher the number, the more money you save. Older systems had SEER numbers as low as 8; the new Carrier systems are rated at 18! (Federal stand aids required a minimum SEER of 13 from January 2006.) Translated into operating costs, this means that for every $100 you used to spend on electricity for cooling, you now can spend just $39.
There are several issues involved in Carrier's pushing more efficient air-conditioning units. First, the market demand is difficult to estimate. Second, it is even more difficult to predict the useful life of the product, as market competition is ever increasing. Carrier's gross margin is about 25%. its operating margin is 8.3%, and its net margin is 7.45%. The expected retail price of the Delux Puron unit is about $4,236. Determine the required sales volume of the new air-conditioning unit to justify the capital investment of $250 million, assuming that Carrier's required return is 15%.
There are several issues involved in pushing more-efficient air-conditioning unit by Carrier.
First, the size of market demand is difficult to estimate. Second, it is even more difficult to predict the useful product life as market competition is ever increasing. Carrier's marketing department has plans to target sales of the new air-conditioning units to the larger office complexes, and if they are successful there, then the units could be marketed to a wide variety of businesses, including schools, hospitals, and eventually even to households.
The marketing vice president believes that annual sales would be 22,000 units if the units were priced at $8,200 each. The engineering department has estimated that the firm would need a new manufacturing plant; this plant could be built and made ready for production in 2 years, once the "go" decision is made. The plant would require a 25-acre site, and Carrier currently has an option to purchase a suitable tract of land for $2.5 million. Building construction would begin in early 2014 and continue through 2015. The building, which would fall into MACRS 39-year class, would cost an estimated $12 million, and a $2 million payment would be due to the contractor on March 31, 2014, another $6 million on March 31, 2015 and remaining balance of $4 million payable on March 31, 2016.
The necessary manufacturing equipment would be installed late in 2015 and would be paid for on March 31, 2016. The equipment, which would fall into the MACRS 7-year class, would have a cost of $8.5 million, including transportation, plus another $500,000 for installation. To date, the company has spent $8 million on research and development associated with the new technology. The company already expensed $2 million of the R D costs, and the remaining $6 million has been capitalized and will be amortized over the life of the project. However, if Carrier decides not to go forward with the project, the capitalized R D expenditures could be written off as expenses on March 31, 2016.
The project would also require an initial investment in net working capital equal to 13% of the estimated sales in the first year. The initial working capital investment would be made on March 31. 2016, and on March 31 of each following year, the net working capital would be increased by an amount equal to 13% of any sales increase expected during the coming year. The project's estimated economic life is 6 years (not counting the construction period). At that time, the land is expected to have a market value of $1.5 million, the building a value of $1.8 million, and the equipment a value of $2.5 million.
The production department has estimated that variable manufacturing costs would total 65% of dollar sales, and that fixed overhead costs, excluding depreciation, would be $7.5 million for the first year of operations. Sales prices and fixed overhead costs, other than depreciation and amortization, are projected to increase with inflation, which is expected to average 5% per year over the 6-year life of the project. (Note that the first year's sales would be $8,200 × 22,000 units = $180.4 million. The second year's sales would be 5% higher than $180.4 million, and so forth.)
Carrier's marginal combined tax rate is 38%; its weighted average cost of capital is 14.5% (meaning that their inflation-adjusted minimum attractive rate of return is 14.5% after tax); and the company's policy, for capital budgeting purposes, is to assume that cash flows occur at the end of each fiscal year (for Carrier, it is March 31). Since the plant would begin operations on April 1, 2016, the first operating cash flows would thus occur on March 31, 2017.
Questions:
1. Determine how you would treat the R D expenditures.
2. Determine the depreciation schedules for all assets.
3. Determine the taxable gains for each asset at the time of disposal (March 31, 2022).
4. Determine the amount of working capital requirement in each operating period.
5. Develop the project cash flows over the life of investment using an Excel spreadsheet.
Justify the investment based on (1) net present worth criteria and (2) internal rate of return.