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 9,000 ships: Direct materials $34,650 Direct labor 31,500 Variable overhead 16,200 Fixed overhead 41,850 Total $124,200 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 $40,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead combined to be reduced by a total of $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 $0.25 more per unit. Fixed overhead costs will increase by $5,000. Finley expects production to be 9,550 ships in each of the next four years. Assume a discount rate of 3%.
REQUIRED
1. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment? 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 9,000 ships: Direct materials $34,650 Direct labor 31,500 Variable overhead 16,200 Fixed overhead 41,850 Total $124,200 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 $40,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead combined to be reduced by a total of $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 $0.25 more per unit. Fixed overhead costs will increase by $5,000. Finley expects production to be 9,550 ships in each of the next four years. Assume a discount rate of 3%.
REQUIRED
1. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment? 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 9,000 ships: Direct materials $34,650 Direct labor 31,500 Variable overhead 16,200 Fixed overhead 41,850 Total $124,200 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 $40,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead combined to be reduced by a total of $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 $0.25 more per unit. Fixed overhead costs will increase by $5,000. Finley expects production to be 9,550 ships in each of the next four years. Assume a discount rate of 3%.
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

Computation of Net Present Value are as follows:-

Particulars 1 2 3 4 Net Savings*             10,758          10,758       10,758          10,758 Salvage Value          40,000 Total Cash Inflows/Savings             10,758          10,758       10,758          50,758 PV Factor 0.9709 0.9426 0.9151 0.8885 Present Value of cash flows             10,444          10,140          9,844          45,098 Total PV of cash flows/Savings             75,527 Less:- Initial Invenstment         (150,000) Net Present Value           (74,473) * Particulars Purchase of new equipment Current Cost Saving Direct Material & Labor cost                                                   54,435             70,193          15,758 Increase in Fixed cost                                                   46,850             41,850          (5,000) Net Savings          10,758 As Net Present Value is negative so purchase of new equipment is not proposed

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