Scenario 4.7
The B. Sharp Company has a rapidly growing product line that requires two work centers, X and Y for manufacture. Work Center X has a current capacity of 50,000 units per year, and Work Center Y is capable of 55,000 units per year. This year (year 0), sales of the product line are expected to reach 50,000 units. Growth is projected at an additional 3,000 units each year through year 3. Pre-tax profits are expected to be $60 per unit throughout the 3-year planning period. Two alternatives are being considered:1) Expand both Work Centers X and Y at the end of year 0 to a capacity of 60,000 units per year, at a total cost for both Work Centers of $500,000;
2) Expand Work Center X at the end of year 0 to 55,000 units per year, matching Work Center Y, at a cost of $300,000, then expanding both Work Centers to 60,000 units per year at the end of year 2, at an additional cost at that time of $350,000.
The Sharp Company will not consider projects that don't show a 3rd year positive net present value using a discount rate of 20%.
-Use the information in Scenario 4.7. What is the pre-tax cash flow (net present value) for alternative #2 compared to the base case of doing nothing for the next five years?
A) negative pre-tax cash flow
B) more than $0 but less than $100,000
C) more than $100,000 but less than $200,000
D) more than $200,000

Question

Quizplus · Accepted Answer

Alternative #2 involves expanding Work Center X at the end of year 0 and both centers at the end of year 2, allowing for sales growth and additional profits over the base case. Despite the initial and subsequent investments, the increased sales and profits at $60 per unit over the years, discounted at 20%, would result in a net present value greater than $100,000 but less than $200,000, considering the costs and the incremental revenue from the additional sales.

Scenario 4.7 The B. Sharp Company Has a Rapidly Growing Product Line