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 2013 for $200,000. It is now early in 2017, 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 total manufacturing costs, when production was 7,400 ships:

The cost of the new equipment is $145,000. It has a four 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 $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 $0.19 more per unit. Fixed overhead costs will increase by $3,600.

Finley expects production to be 7,800 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?

Explanation / Answer

Annual saving in cost: Labour cost and variable OH (7800 units @1.95) 15210 Less: Increase in material (7800 units @ 0.15) 1170 Less: Increase in Fixed cost 3600 Annual savings in cost 10440 Net present value: Prsent value of Annual saving in cost for 4 years ($ 10,440 * Present Annuity factor i.e. 3.546) 37020 Present value of salvaage value of new equipment ($ 40,000 *PV factor i.e. 0.8227) 32908 Total Present value of cash inflows 69928 Less: Nitial Investment less salvage value of old equipment 115,000 NET PRESENT VALUE -45,072

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.