The B&E Cooling Technology Company, a maker of automobile air-conditioners, faces a threeyear deadline to phase out the traditional chilling technique, which uses chlorofluorocarbons (CFCs)— a family of refrigerant chemicals believed to attack the earth’s protective ozone layer. B&E has been pursuing other means of cooling and refrigeration. As a near-term solution, the engineers recommend a cold technology known as an absorption chiller, which uses plain water as a refrigerant and semiconductors that cool down when charged with electricity. B&E is considering two options.
• Option 1. Retrofit the plant now to adapt the absorption chiller and continue to be a market leader in cooling technology. Because of untested technology on a large scale, it may cost more to operate the new facility while personnel are learning the new system.
• Option 2. Defer the retrofitting until the federal deadline, which is three years away. With expected improvement in cooling technology and technical know-how, the retrofitting cost will be cheaper. However, there will be tough market competition, and the revenue would be less than that of option 1.
The financial data for the two options are as given in Table ST7.3.
(a) What assumptions must be made to compare these two options?
(b) If B&E’s MARR is 15%, which option is the better choice based on the IRR criterion?
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The Hamilton Flour Company is currently operating its mill six days per week, 24 hours per day, on three shifts. At current prices, the company could easily obtain a sufficient volume of sales to take the entire output of a seventh day of operation each week. The mill’s practical capacity is 6,000 hundredweight of flour per day. Note that:
• Flour sells for $20.24 per hundredweight (cwt) and the price of wheat is $8.35 per bushel. About 2.35 bushels of wheat are required per cwt of flour.
Fixed costs now average $8,520 per day (or $1.42 per cwt). The average variable cost of mill operation, almost entirely wages, is $0.68 per cwt.
• With Sunday operation, wages would be doubled for Sunday work, which would bring the variable cost of Sunday operation to $1.36 per cwt. If the mill were to operate on Sunday, the daily fixed cost would increase by $850, such that the total fixed cost for a 7-day operation would be $51,970.
(a) Using the information provided, compute the break-even volumes for six-day and seven-day operation.
(b) What are the marginal contribution rates for six-day and seven-day operation?
(c) Compute the average total cost per cwt for six day operation and the net profit margin per cwt before taxes.
(d) Would it be economical for the mill to operate on Sundays? (Justify your answer numerically.)
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As Boeing and other aircraft manufactures are planning to use more aluminum lithium alloys for their future aircrafts, the American Aluminum Company is considering making a major investment of $150 million ($5 million for land, $45 million for buildings, and $100 million for manufacturing equipment and facilities) to develop a stronger, lighter material called aluminum lithium that will make aircraft sturdier and more fuel-efficient. Aluminum lithium, which has been sold commercially for only a few years as an alternative to composite materials, will likely be the material of choice for the next generation of commercial and military aircraft because it is so much lighter than conventional aluminum alloys, which use a combination of copper, nickel, and magnesium to harden aluminum. Another advantage of aluminum lithium is that it is cheaper than composites. The firm predicts that aluminum lithium will account for about 5% of the structural weight of the average commercial aircraft within five years and 10% within 10 years. The proposed plant, which has an estimated service life of 12 years, would have a capacity of about 10 million pounds of aluminum lithium, although domestic consumption of the material is expected to be only 3 million pounds during the first four years, 5 million for the next three years, and 8 million for the remaining life of the plant. Aluminum lithium costs $12 a pound to produce, and the firm would expect to sell it at $17 a pound. The buildings will be depreciated according to the 39-year MACRS real property class, with the buildings placed in service on July 1 of the first year. All manufacturing equipment and facilities will be classified as seven-year MACRS properties. At the end of the project life, the land will be worth $8 million, the buildings $30 million, and the equipment $10 million. Assuming that the firm’s marginal tax rate is 40% and its capital gains tax rate is 35%, determine the following:
(a) The net after-tax cash flows.
(b) The IRR for this investment.
(c) Whether the project is acceptable if the firm’s MARR is 15%.
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