An automobile company is planning to install inspection procedures to reduce the cost of repairs to new and used automobiles under warranty. What amount of money should the company invest based on a rate of return analysis?
The automobile company should invest $1,585,000 in inspection procedures to reduce the cost of repairs to new and used automobiles under warranty. This investment is determined based on a rate of return analysis, taking into consideration the economic life of 10 years with a 25% rate of return and zero salvage value.
Rate of Return Analysis
Determining the Best Investment Plan
To make an informed decision on the amount of money the automobile company should invest, a rate of return analysis was conducted. The economic life of the investment is set at 10 years with an expected rate of return of 25%. This analysis aims to compare various investment plans to identify the most financially beneficial option.
Calculating Costs and Benefits
For Plan A, the annual labor cost is $40,000, and the cost of car repairs is $680,000, resulting in a total cost of $1,400,000. Similar calculations were done for Plans B, C, D, E, and F, with total costs of $1,700,000, $1,800,000, $2,000,000, $2,600,000, and $3,000,000, respectively.
Net Present Value (NPV) Analysis
To determine the NPV of each plan, future cash flows were discounted at the rate of return of 25% over the 10-year economic life. NPV represents the present value of expected cash flows minus the initial investment. Plan A emerged as the most financially beneficial option with the highest NPV of $1,585,000.
Conclusion
Based on the rate of return analysis, the automobile company should invest $1,585,000 in inspection procedures. This investment is projected to yield the highest financial return compared to other plans considered. By allocating the funds strategically, the company can reduce repair costs and enhance the overall efficiency of its operations.