Applied Managerial Accounting
Instructor Crystal Gifford
January 15, 2012
From: Corporate Business Financial Analyst
To: Charles Jackson, General Manager
Date: February 5, 2012
RE: SAC Spark Plug Project Analysis
Dear Mr. Jackson,
This memo is concerning the analysis of the specialty spark plug project and taking a look at key financial metrics regarding the capital budgeting process of the potential purchase of new equipment and manufacturing of the specialty spark plugs. This memo will be discussing net present value (NPV), internal rate of return (IRR), and the payback period. In addition, this memo will be discussing the effects of a sales volume increase (total fixed costs, unit fixed costs, total variable costs, and unit variable costs), the effects of a volume increase in sales, a price increase in sales, and a cost decrease on the net operating income, and finally will discuss a recommendation for SAC.
The first to discuss is the net present value (NPV). NPV is used to analyze whether a project or investment will be profitable for a company and is responsive to the dependability of future inflows that a project or investment will yield. The NPV does a comparison of a dollars value today to the future dollar value, while taking into account inflation and returns. If the NPV of a potential project is positive, then the project is accepted, but if it is negative, then the project should be rejected, since the cash flow would be negative as well (Garrison, 2012).
Next is the internal rate of return (IRR), which is the rate of return that is guaranteed by the investments of a project over the life of the project. The IRR is calculated by finding the discounted rate that compares to the present value cash outflow of a project with the present value of the cash inflow. In other words, the IRR is “the discounted rate that will cause the net present value to be equal to zero” (Accounting for Management,...