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Too Hot to Handle

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Submitted By zainabhy
Words 535
Pages 3
Questions 1-7:

1. Develop operating cash flow forecasts for the relevant lives of each type of tanning equipment using 100% (Best case), 80% (Most Likely Case), and 50% (Worst Case) occupancy estimates for each tanning option. Assume straight line depreciation and a tax rate of 30%.
Please see the attached file(Excel)

2. Calculate and comment upon the accounting, cash, and financial break-even sales for the dome unit and the tanning bed unit respectively.

The tanning bed unit has a lower breakeven for all accounting, cash and financial. The calculation is in the attached file(Excel)

3. Calculate the net present value, payback period, and the traditional IRR for each tanning option under the various scenarios. What do the decision rules indicate?

The NPV is higher for the dome unit, but the tanning unit has a lower payback and a higher IRR. Decision rule would suggest that higher NPV, lower payback and higher IRR should be accepted. Under mutually exclusive situation as we have here where we need to select between dome or tanning bed, we should select based on NPV.

4. Can Patsy evaluate this business project by assuming just a onetime purchase? Why or why not? What other evaluation methods should Patsy use?

Since the life of the units is different, we cannot assume a one time purchase. We need to use the replacement chain approach and assume that we will purchase again over a 40 year time period which when both will have the same life. Dome unit would have 8X5=40 - 5 purchases and tanning bed would be 5X8=40 - 8 purchases.
We can also use the Equivalent annual annuity (EAA) method where we calculate the NPV per year so that we can evaluate projects with unequal lives.

5. If you decide to use the replacement chain method, how do the calculation and decision change?

In replacement chain method, we would need to do the analysis for 40 years which is the minimum

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