Question

A company plans to invest for a production plant. Annual production plan is 45 million units. The investment at time 0 that is required for building the manufacturing plant is estimated as $200 million, and the economic life of the project is assumed to be 8 years. The annual total operating expenses, including manufacturing costs and overheads, are estimated as $115 million. The salvage value that can be realized from the project is estimated as $60 million. If the company’s interest is 15%, determine the minimum price that the company should have for the product so that the total costs are covered.

Select one:

a. 4.91

b. 6.45

c. 7.51

d. 2.33

e. 3.44

f. 5.91

Answer 1

Solution :-

To Find The Minimum Price we need to take equal Present Value of cash Inflows and Initial Cots

= Initial Cost = ( Annual Revenue - Annual Exps ) * PVAF ( r , n ) + Salvage Value * PVF ( r , n )

= $200 million = ( Annual Revenue - $115 million ) * PVAF ( 15% , 8 ) + $60 million * PVF ( 15% , 8 )

= $200 million = ( Annual Revenue - $115 million ) * 4.487 + ( $60 * 0.3269 )

= $200 million - $19.614 million = ( Annual Revenue - $115 million ) * 4.487  

( Annual Revenue - $115 million ) = $40.20 million

Annual Revenue = $155.20 million

Minimum Annual Revenue Required = $155.20 million

Now Annual Production = 45 million Units

Therefore Minimum Price Required per Unit = $155.20 / 45 = 3.44 Per unit

Therefore Correct Answer is (e)

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