Problem 1: 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.
Required:
(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?
Problem 2: 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.
Required:
(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.