Smooth-Top is a manufacturer of desktops. It is considering an increase of capacity. Consulting engineers have submitted two routes to accomplish this: (1) install a new production line that would produce wooden desktops finished with hardwood veneer and (2) install a new production line that would produce wooden desktops finished with simulated wood made from hard plastic.
Smooth-Top is concerned about the price of hardwood veneer. The y believe the price of veneer will rise over the next 10 years. However, they believe the price of veneer-finished desktops will rise by less than the rate at which the price of veneer rises. Information about the two potential projects is in the following table.
(a) Compute the present worth of each option under the assumption that the real price of hardwood-finished desktops and real cost of hardwood veneer do not change (rather than as stated in the table). Assume zero inflation.
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Smooth-Top Desktop Project
|
|
Plastic-finish real price and real cost change
|
0%
|
|
Veneer-finish expected real price change
|
1%
|
|
Veneer-finish expected real cost change
|
5%
|
|
Wood cost/unit($)
|
12.5
|
|
Plastic cost/unit($)
|
9
|
|
Wood price/unit($)
|
32
|
|
Plastic price/unit($)
|
26
|
|
Wood first cost($)
|
2,050,000
|
|
Plastic First cost($)
|
2,700,000
|
|
Wood output rate(Units/year)
|
30,000
|
|
Plastic output rate(Units/Year)
|
45,000
|
|
Study period
|
10 years
|
|
Actual dollar ALARR
|
25%
|
(b) Compute the present worth of each option under the assumption that the real price of hardwood-finished desktops and the real value of hardwood veneer desktop operating costs increase as indicated in the table. Assume that inflation is expected to be 2% over the study period.