Question #1
Discounted Cash Flow models use a hurdle rate, or the desired rate of return, to compute the present value of future cash flows. Briefly describe how management might determine the hurdle rate for an investment opportunity.

Question #2
Ol' Salt Enterprises

Purchase price per set of sails $250
Estimated variable costs per set of sails $195
Sets of sails needed 2,000
Estimated rent on vacant factory space $200,000
Allocated fixed costs $500,000

Ol' Salt Enterprises produces 2,000 sailboats per year. Although the company currently buys sails for the sailboats (one set of sails per boat), it is considering making sails in some space that it does not currently use. The company purchases each set of sails for $250. It could make the sails for variable costs of $195 per set, plus it would allocate $500,000 of fixed costs per year to the sail-making operation. However, this $500,000 is not a differential cost of making sails; it is part of the costs the company already incurs that it would allocate away from sailboat manufacture to sail making.

a. How would it affect Ol' Salt's profit if it makes the sails rather than buys the sails? Show your work.
b. If Ol' Salt continues to buy the sails, it would have unused factory space. Suppose Ol' Salt received an offer to rent out this unused factory space for $200,000 per year. How would it affect Ol' Salt's profit if it makes the sails rather than buys the sails? Show your work.

Question #3
Acme Company (A, B, C & Total)
Sales $42,000 $25,000 $45,000 $112,000
Variable costs 27,500 20,500 38,000 86,000
Contribution margin 14,500 4,500 7,000 26,000
Fixed costs 5,000 8,000 5,000 18,000
Operating profit (loss) 9,500 (3,500) 2,000 8,000

Acme Company has three product lines. Acme's income statement, segmented by product lines, is provided at the left. Due to continuing losses, Acme is considering discontinuing Product Line B.
a. What would be the effect on Acme's operating profit if it discontinued Product Line B? Show your work.
b. How would your answer be different if $6,000 of Product Line B’s fixed costs were avoidable? Show your work.
c. What if by dropping Product Line B, Acme could increase the volume of Product Line A by 75% without affecting fixed costs? Show your work.

Question #4
A company is considering outsourcing the production of a key component of its primary product. An analysis of differential costs indicates that the company could save $1,000,000 per year by outsourcing. Savings of this magnitude are significant to this company. Briefly describe the qualitative aspects of outsourcing that must be considered prior to making the decision of whether or not to outsource the production of this component.

Question #5
A proposed project has a negative net present value (NPV). Does this mean that the project has a negative internal rate of return (IRR)? Why or why not?

Question #1 Discounted Cash Flow models use a hurdle rate, or the...