Nautical Creations is one of the largest producers of miniature ships in a bottl

Question

Nautical Creations is one of the largest producers of miniature ships in a bottle. An especially complex part of one of the ships needs special production equipment that is not useful for other products. The company purchased this equipment early in 2012 for $200,000. It is now early in 2015, and the manager of the Model Ships Division, Jeri Finley, is thinking about purchasing new equipment to make this part. The current equipment will last for four more years with zero disposal value at that time. It can be sold immediately for $30,000. The following are last year's per-unit manufacturing costs, when production was 8,600 ships:

The cost of the new equipment is $150,000. It has a four year useful life with an estimated disposal value at that time of $30,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead to be reduced by $1.95 per unit." Finley thinks this estimate is accurate, but also knows that a higher quality of direct material will be necessary with the new equipment, costing $0.17 more per unit. Fixed overhead costs will increase by $5,000.

Finley expects production to increase to 9,050 ships in each of the next four years. Assume a discount rate of 5%.

REQUIRED

1. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?

Direct materials $3.70 Direct labor 3.70 Variable overhead 1.80 Fixed overhead 4.55 Total unit cost $13.75

Explanation / Answer

FOR OLD EQUIPMENT => MANUFSCTURING COST = 8600 * 13.75 => $118250

COST => 118250 + 42500 => 160750

TOTAL COST => 160750 - 30000 => $130750

FOR NEW EQUIPMENT

NEW MACHINE COST= > 111282 + DEPRECIATION (150000-30000)/4

=> 111282+30000 => $ 141282

TOTAL COST => 141282 - 30000 => $ 111282

NOTE: SELLING PRICE NOT GIVEN, IMPOSSIBLE TO CALCULATE NPV, BUT ON THE BASIS OF COST STRUCTURE, NEW MACHINE IS BETTER TO BE INSTALLED AS ITS COST PRICE OF EQUIPMENT IS ALSO LESS BY 50000

DIREC MATERIAL (9050 * 3.87) 35024 DIRECT LABOUR & VAR. O/H (9050* 3.55) 32128 FIXED OVERHEAD (8600* 4.55) + 5000 44130 TOTAL MANUFACTURING COST 111282

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