Relevant cash flows and calculation of NPV and IRRA car manufacturer has been experiencing financial...
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Relevant cash flows and calculation of NPV and IRR
A car manufacturer has been experiencing financial difficulties over the past few years. Sales have reduced significantly as a result of the worldwide economic recession. Costs have increased due to quality issues that led to a recall of some models of its cars.
Production volume last year was 50,000 cards and it is expected.
The company directors are concerned to improve profitability and are considering two potential investment projects.
Project 1: Implement a new quality control process
The company has paid a consultant process engineer $50,000 to review the company's quality processes. The consultant recommended that the company implemented a new quality control process. The new process will require a machine costing $20,000,000. The machine is expected to have a useful life of 5 years and no residual value.
It is estimated that raw material costs will be reduced by $62 per car and that both internal and external failure costs from quality failures will be reduced by 80 per cent.
Estimated internal and external failure costs per year without the new process based on last year's production volume of 50,000 cars and their associated probabilities are shown below.
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