Investment in Technology:
Lexington Auto Parts is considering installation of a CIM as part of its implantation of a CIM system as part of its implementation of a JIT philosophy. Carley Rupp, company president is convinced that the new system is necessary; and approval at board level is required.
Leah Rupp, Carley's daughter, has been assigned the task of justifying the investment. She is a business school graduate and understands the use of NPV for capital-budgeting decisions. To identify relevant costs, she developed the following information.
Lexington Auto Parts Company produces a variety of small automobile components and sells them to auto manufacturers. It has a 40% market share, with the following condensed results expected for 2007:
Sales $ 12,000,000
Cost of goods sold
Variable $ 4,000,000
Fixed $ 4,300,000 $ 8,300,000
Selling and admin expenses
Variable $ 2,000,000
Fixed $ 400,000 $ 2,400,000
Operating Income $ 1,300,000
Installation of the CIM system will cost $5 million and the company expects the system to have a useful life of six years with no salvage value. Installation will occur at the beginning of 2008. In 2008, the training cost for personnel will exceed any cost savings by $400,000. In years 2009 through 2013, variable cost of goods sold will decrease by 35%, an annual savings of $1.4 million. There will be no savings in fixed cost of goods sold â?" it will increase by the amount of the straight-line depreciation on the new system. Selling and administrative expenses will not be affected. The required rate of return is 12%. Assume that all cash flows occur at the end of the year, except the initial investment, which occurs at the beginning of 2008.
1. Suppose that Leah Rupp assumes that production and sales would continue for the next six years as they are expected in 2007 in the absence of investment in the CIM. Compute the NPV of investing in the CIM.