Reference no: EM132772341

Problem - AutoSource Inc. designs and manufactures tires for automobiles. The company's strategy is to design products that incorporate the full environmental impact of the product over its life cycle. This includes designing tires for fuel efficiency.

The technical team has determined that the tires manufactured with a silica blend will reduce road resistance. Thus, silica-blended tires will be significantly more fuel-efficient for the consumer, without compromising tire life. To produce the silica-blended tires, AutoSource will need to invest $5,000,000 in new equipment. It is expected that the new tire will be attractive to consumers and will result in increased tire sales. However, sales of conventional tires will be reduced as a result of the new silica-based tires. To evaluate the project, the cost and prices of silica and conventional tires are estimated as follows:

	Silica Tires	Conventional Tires
Sales price per tire	$160	$140
Conventional Tires	80	70
Variable manufacturing cost per tire	15	12

It is anticipated that 80,000 silica tires will be sold annually, while the sales of conventional tires will be reduced by 70,000 tires annually.

Required -

a. Determine the annual contribution margin for manufacturing and selling the silica-blended tires.

b. Determine the annual cash flows of manufacturing and selling silica-blended tires, incorporating the impact of lost sales from conventional tires.

c. Prepare a net present value analysis of the silica equipment investment, assuming an eight-year life and 12% minimum rate of return.