Saxon Products, Inc., is investigating the purchase of a robot for use on the co

Question

Saxon Products, Inc., is investigating the purchase of a robot for use on the company's assembly line. Selected data relating to the robot are provided below: $2,000,000 $820,000 Cost of the robot Installation and software Annual savings in labor costs Annual savings in inventory carrying costs Monthly increase in power and maintenance costs Salvage value in 5 years Useful life $330,000 $3,000 $87,000 5 years Engineering studies suggest that use of the robot will result in a savings of 20,000 direct labor-hours each year. The labor rate is $9 per hour. Also, the smoother work flow made possible by the use of automation will allow the company to reduce the amount of inventory on hand by $420,000. This inventory reduction will take place at the end of the first year of operation; the released funds will be available for use elsewhere in the company. Saxon Products has a 9% required rate of return. Shelly Martins, the controller, has noted that all of Saxon's competitors are automating their plants. She is pessimistic, however, about whether Saxon's management will allow it to automate. In preparing the proposal for the robot, she stated to a colleague, "Let's just hope that reduced labor and inventory costs can justify the purchase of this automated equipment. Otherwise, we'll never get it. You know how the president feels about equipment paying for itself out of reduced costs." Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Determine the annual net cost savings if the robot is purchased. (Do not include the $420,000 inventory reduction or the salvage value in this computation.) Savings in labor costs Savings in inventory carrying costs Total Less increased power and maintenance cost Annual net cost savings $ 0

Explanation / Answer

1 Savings in labor cost $180,000 (20000*$9) Saving in inventory carrying cost $330,000 Total $510,000 Less Increased power and maintenance cost $3,000 Annual net cost savings $507,000 NOW N YEAR 0 1 2 3 4 5 A Cost of the robot ($2,000,000) B Installation and software ($820,000) C Annual net cost savings $507,000 $507,000 $507,000 $507,000 $507,000 D Inventory reduction $420,000 E Salvage value(old) $87,000 F=A+B+C+D+E Total Cash flow ($2,820,000) $927,000 $507,000 $507,000 $507,000 $594,000 G=1/(1.09^N) Discount factor (9%) 1 0.917431 0.84168 0.772183 0.708425 0.649931 SUM PV=F*G Present value ($2,820,000) $850,459 $426,732 $391,497 $359,172 $386,059 ($406,082) NPV=SUM OF PV Net Present Value ($406,082) 2b Based on the above date Recommendation : NO (Becasuse NPV is negative) 3a Savings in labor cost $81,000 (9000*$9) Saving in inventory carrying cost $330,000 Total $411,000 Less Increased power and maintenance cost $3,000 Annual net cost savings $408,000 NOW N YEAR 0 1 2 3 4 5 A Cost of the robot ($2,000,000) B Installation and software ($1,030,000) C Annual net cost savings $408,000 $408,000 $408,000 $408,000 $408,000 D Inventory reduction $420,000 E Salvage value(old) $87,000 F=A+B+C+D+E Total Cash flow ($3,030,000) $828,000 $408,000 $408,000 $408,000 $495,000 G=1/(1.09^N) Discount factor (9%) 1 0.917431 0.84168 0.772183 0.708425 0.649931 SUM PV=F*G Present value ($3,030,000) $759,633 $343,405 $315,051 $289,037 $321,716 ($1,001,157) NPV=SUM OF PV Net Present Value ($1,001,157) 3b NO , Company did mot make a wise investment

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