Question

Southern specialty products has production facilities in Mississippi and Japan. Both facilities have capacities of 2 million units each per year. The cost of production and distribution of party supplies from Mississippi is $0.25/unit. The cost of production and distribution from Japan is 25 Yen/unit. (Assume that the current exchange rate is $1=110 Yen). Over the next two years the exchange rate is expected to strengthen by 7.5% with a 0.5 probability and weaken by 7.5% with a probability of 0.5.

The expected demand this year is about 3.5 million units. Over the next two years the demand is expected to increase by 10% with a probability of 0.5 and decrease by 8% with a probability of 0.5. If demand is more than the capacity of the two plants then the remaining supplies are acquired from a competitor for $0.8/unit.

What is the NPV of total cost with the current manufacturing setup?
The company wants to increase the capacity of the Mississippi plant by 500,000 units at a fixed cost of $100,000. The fixed cost will be incurred this year. What is the NPV of the revised setup?
Should They do it? Assume that the company uses a 10% discount rate.

Answer 1

The answer calculates the NPV of Southern specialty products' current and revised manufacturing setups by assessing production costs, demand forecasts, and exchange rate fluctuations to determine the most cost-effective strategy.

Step-by-step explanation:

The Net Present Value (NPV) of total cost with the current manufacturing setup for Southern specialty products is calculated by considering the production and distribution costs from both Mississippi and Japan factories against the projected demand, exchange rates, and the probability of demand changes.

The NPV of the revised setup, which includes a capacity increase in the Mississippi plant, involves an additional fixed cost but possibly lower variable costs per unit due to increased production. The decision to increase capacity should be made by comparing the NPV of the current setup with the NPV of the revised setup and determining which provides a higher NPV at the 10% discount rate.