This is a decision to keep or replace current equipment, mutually exclusive alte

Question

This is a decision to keep or replace current equipment, mutually exclusive alternatives. The question asks for the difference in the net present values of the two alternatives, not the net present value of one or the other. Use the present value tables on page 118 to compute present values.

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 six more years with zero disposal value at that time. It can be sold immediately for $35,000. The following are last year's per-unit manufacturing costs, when production was 8,600 ships:

The cost of the new equipment is $135,000. It has a six year useful life with an estimated disposal value at that time of $40,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead to be reduced by a total of $2.05 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 decrease by $3,400. Finley expects production to increase to 9,150 ships in each of the next six years. Assume a discount rate of 5%.

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

Direct Materials $3.85 Direct Labor $3.75 Variable Overhead $1.80 Fixed Overhead $4.60 Total Unit Cost $14.00

Explanation / Answer

New Machine Cost of New machine -$1,35,000 Less: disposal of exisiting Machine $35,000 Net Purchase Value -$1,00,000 Changes in costs with new machine -per year Labor & Overhead $18,758 Cost of Direct material -$1,556 Fixed costs $3,400 Net savings in cost $20,602 Present value factor 5.07569 Net present value of Annuity of net savings $1,04,569 Estimated disposal value at the end of six years $40,000 Present value factor 0.74622 Present value of disposal value $29,849 Total Present Value $1,34,418 Difference in present value if the new equipment is purchased $34,418

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