(A) Network Service Center is considering purchasing a new computer network for $82,000. It will require additional working capital of $13,000. Its anticipated eight-year life will generate additional client revenue of $33,000 annually with operating costs, excluding depreciation, of $15,000. At the end of eight years, it will have a salvage value of $9,500 and return $5,000 in working capital. Taxes are not considered.
(i) If the company has a required rate of return of 14%, what is the net present value of the proposed investment?
(ii) What is the internal rate of return?
(B) Collier Bicycles has been manufacturing its own wheels for its bikes. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labor cost. The direct materials and direct labor cost per unit to make the wheels are $1.50 and $1.80, respectively. Normal production is 200,000 wheels per year.
A supplier offers to make the wheels at a price of $4 each. If the bicycle company accepts this offer, all variable manufacturing costs will be eliminated, but the $42,000 of fixed manufacturing overhead currently being charged to the wheels will have to be absorbed by other products.
(i) Prepare an incremental analysis for the decision to make or buy the wheels.
(ii) Should Collier Bicycles buy the wheels from the outside supplier? Justify your answer.
The costing rate of returns, NPV, and incremental analysis is examined.