Nautical Creations is one of the largest producers of miniature ships in a bottl
ID: 2449413 • Letter: N
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 $25,000. The following are last year's per-unit manufacturing costs, when production was 8,000 ships:
The cost of the new equipment is $140,000. 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 $1.90 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 $0.23 more per unit. Fixed overhead costs will increase by $3,000.
Finley expects production to increase to 8,600 ships in each of the next four years. Assume a discount rate of 3%.
Questions:
What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?
Direct materials $3.85 Direct labor 3.50 Variable overhead 1.70 Fixed overhead 4.70 Total unit cost $13.75Explanation / Answer
Current Total Fixed Overhead= 4.7*8000 units = $ 37,600.00 Expected Fixed cost with new machine $ 40,600.00 Details variable cost/unit with new machine variable cost/unit with oild machine Direct Material 3.85 4.08 Direct Labor & Var OH 5.2 3.3 Total Variable cost /unit 9.05 7.38 Total units produced 8000 8600 Total variable cost of production 72400 63468 Fixed cost 37600 40600 Total cost of production 110,000 104,068 Unit cpst of production 13.75 12.10 Saving in cost /unit 1.65 Total saving in 8600 units 14,182.00 Useful life of machine 8 4 Depreciatble value of machine 0 30000 Depreciation /year 25000 27500 Increase in depreciation cash flow /year 2500 Total incremental cash flow per year 16,682.00 Details Year 0 Year 1 Year 2 Year 3 Year 4 Initial cost (140,000) Sales proceeds second machine 25,000 Salvage value 30,000 Incremental cash flow 16,682 16,682 16,682 16,682 Discount rate @3% 1 0.971 0.943 0.915 0.888 Net Cash Flows (115,000) 16,682 16,682 16,682 46,682 PV of cash flows (115,000) 16,196 15,724 15,266 41,476 NPV (26,337) So the differential NPV of the new machine purchase is $ (26,336.75)
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