Component Technologies, Inc.
Component Technologies, Inc 1) Prepare the manufacturing staff’s calculations for the three alternatives (please refer to the attachments): a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?
During the period of 5 years (from 1994 to 1998), if the discount rate is 20%, Waltham plant is the only one that has a positive amount in NPV. The total net present value of this plant is approximately $6.4 million, while the other two plants have a negative number (Santa Clara: negative $3,882,499; Greenfield: negative $29,386,827).
The reason is that the cost to conduct the three plans is significantly different. While it costs only $7 million for Waltham, $23 million is required for Santa Clara and $61 million is for Greenfield.
It is note that the additional fixed cost in the three plants is also different. In Santa Clara, the additional fixed cost is $2.1 million annually and rises to $2.4 million beginning from 1997. The plant in Waltham spends more in fixed cost than Santa Clara. $2.4 million is annually added to the total fixed cost from 1995 to 1996. From 1997, that amount will rise up to $2.6 million. Plan of Greenfield will add the highest amount to total fixed cost (additional $2.8 million annually from 1995-1998, and $2.9 million annually from 1999)
Even though the new plant in Greenfield could lower the variable cost to $0.195 per unit, in short-term (five years), this advantage is still not attractive in comparison with the high other expenses for it. b) In the second set, they used a 10% discount rate. What happens to the NPV of each alternative? What happens to their attractiveness? Why?
The lower discount rate improved the NPV of all alternatives. NPV in Santa Clara turns to positive with the discount rate of 10%. NPV in Waltham increases from $6,384,810 (discount rate 20%) to
During the period of 5 years (from 1994 to 1998), if the discount rate is 20%, Waltham plant is the only one that has a positive amount in NPV. The total net present value of this plant is approximately $6.4 million, while the other two plants have a negative number (Santa Clara: negative $3,882,499; Greenfield: negative $29,386,827).
The reason is that the cost to conduct the three plans is significantly different. While it costs only $7 million for Waltham, $23 million is required for Santa Clara and $61 million is for Greenfield.
It is note that the additional fixed cost in the three plants is also different. In Santa Clara, the additional fixed cost is $2.1 million annually and rises to $2.4 million beginning from 1997. The plant in Waltham spends more in fixed cost than Santa Clara. $2.4 million is annually added to the total fixed cost from 1995 to 1996. From 1997, that amount will rise up to $2.6 million. Plan of Greenfield will add the highest amount to total fixed cost (additional $2.8 million annually from 1995-1998, and $2.9 million annually from 1999)
Even though the new plant in Greenfield could lower the variable cost to $0.195 per unit, in short-term (five years), this advantage is still not attractive in comparison with the high other expenses for it. b) In the second set, they used a 10% discount rate. What happens to the NPV of each alternative? What happens to their attractiveness? Why?
The lower discount rate improved the NPV of all alternatives. NPV in Santa Clara turns to positive with the discount rate of 10%. NPV in Waltham increases from $6,384,810 (discount rate 20%) to