POSTAUDIT, SENSITIVITY ANALYSIS

Newmarge Products Inc. is evaluating a new design for one of its manufacturing processes. The new design will eliminate the production of a toxic solid residue. The initial cost of the system is estimated at $860,000 and includes computerized equipment, software, and installation. There is no expected salvage value. The new system has a useful life of eight years and is projected to produce cash operating savings of $225,000 per year over the old system (reducing labor costs and costs of processing and disposing of toxic waste). The cost of capital is 16 percent.

Required:

1. Compute the NPV of the new system.

2. One year after implementation, the internal audit staff noted the following about the new system: (1) the cost of acquiring the system was $60,000 more than expected due to higher installation costs, and (2) the annual cost savings were $20,000 less than expected because more labor cost was needed than anticipated. Using the changes in expected costs and benefits, compute the NPV as if this information had been available one year ago. Did the company make the right decision?

3. Upon reporting the results mentioned in the postaudit, the marketing manager responded in a memo to the internal auditing department indicating that revenues had increased by $60,000 per year because of increased purchases by environmentally sensitive customers. Describe the effect that this has on the analysis in Requirement 2.

4. Why is a postaudit beneficial to a firm?