Oil Well Company Case Solution

5-Find NPV=?

Data based on the case :

* Variable overhead represents the same percentage of costs as fixed overhead Variable Overhead = Fixed Overhead = X

* If the microprocessors cost $25,000 and their installation runs another $5,000. Assume a 10% margin.

* The microprocessors could cut the production time by 1 percent and reduce scrap by 0.5%.

* Annual Sales: $25 Million

Solution:

* Direct Labor: 5%

* Indirect Labor: 5%

* Material: 60% (copper rods, lead, polypropylene, nylon, and rubber)

* Fixed Overhead: X

* Variable Overhead: X

2X+5%+5%+60% = 100 % X= 15%

If Annual Sales are $25.000.000 and we assume a 10% margin, assumed cost is $22.500.000 {25.000.000 – (25.000.000 x 10%)}

Item | Percentage | Amount in $ | Percentage of Savings | Savings in $ |

Direct Labor | 5% | 22.500.000 x 5% = $ 1,125,000 | N\A | N\A |

Indirect Labor | 5% | 22.500.000 x 5% = $ 1,125,000 | N\A | N\A |

Material | 60% | 22.500.000 x 60% = $ $13,500,000 | 0.5%(scrap) | 13,500,000 x 0.5% =$ 67.500 |

Fixed Overhead | 15% | 22.500.000 x 15% = $ 3.375.000 | N\A | N\A |

Variable Overhead | 15% | 22.500.000 x 15% = $ 3.375.000 | 1%(production time) | 3.375.000 x 1% = $ 33.750 |

Total Savings in $ : $67.500 + $ 33.750 = $ 101.250

Thanks to savings, we could generate extra income $101.250 yearly. We can calculate the Payback period in order to evaluate that this investment is good or bad.

Monthly Total Cost: The microprocessors cost + Installation costs ( 25.000 + 5.000 = $30.000)

Payback Period: $30,000 (12)/ $101,250 = 3.6 months

* It means that we could recover the cost of investment just in 3.6 months so we could say that it is very wise and good investment .