Nautical Creations is one of the largest producers of miniature ships in a bottl
ID: 2553356 • 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 used 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 six more years with zero disposal value at that time. It can be sold immediately for $25,000. The following are last year's total manufacturing costs when production was 8,800 ships:
The cost of the new equipment is $145,000. It has a six-year useful life with an estimated disposal value at that time of $50,000. 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 $2.20 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 decrease by $4,600.
Finley expects production to be 9,300 ships in each of the next six 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
Production of 8800 ships using old machine
Particulars
Total Cost
Cost per unit
Direct Material
$ 34,320
$ 3.90
Direct Labor
$ 32,560
$ 3.70
Variable Overhead
$ 15,840
$ 1.80
Fixed Overhead
$ 37,840
Total Cost
$ 120,560
Total Variable cost per unit
$ 9.40
If new equipment is purhased
Changes in the variable cost per unit
= 9.4 - 2.2 + 0.19
$ 7
Prodution of units
9300
Calculation of yearly costs
Old Machine
New Machine
No. of ships produced
8800
9300
Variable cost per ship
$ 9
$ 7
Total Variable Costs
$ 82,720
$ 68,727
Fixed Overhead
$ 37,840
$ 33,240
= 37840 - 4600
Total Annual Costs
$ 120,560
$ 101,967
Calculation of Net Present Value
Year
Particulars
Old Machine
New Machine
Cash Flow
Discounting Factor @ 3%
Discounted Cash Flow
Cash Flow
Discounting Factor @ 3%
Discounted Cash Flow
0
Purchase of Machinery
$ 120,000
1
$ 120,000
1 - 6
Total Cost of Production of Ships
$ 120,560
5.42
$ 653,435
$ 101,967
5.42
$ 552,661
6
Disposal of asset
$ (50,000)
0.84
$ (42,000)
Net Present Value
$ 653,435
$ 630,661
The difference between the net present value of both the options is
$ 22,774
It is advisable to buy the new machine because the net outflow is less as compared to the outflow from using the old machine
Production of 8800 ships using old machine
Particulars
Total Cost
Cost per unit
Direct Material
$ 34,320
$ 3.90
Direct Labor
$ 32,560
$ 3.70
Variable Overhead
$ 15,840
$ 1.80
Fixed Overhead
$ 37,840
Total Cost
$ 120,560
Total Variable cost per unit
$ 9.40
If new equipment is purhased
Changes in the variable cost per unit
= 9.4 - 2.2 + 0.19
$ 7
Prodution of units
9300
Calculation of yearly costs
Old Machine
New Machine
No. of ships produced
8800
9300
Variable cost per ship
$ 9
$ 7
Total Variable Costs
$ 82,720
$ 68,727
Fixed Overhead
$ 37,840
$ 33,240
= 37840 - 4600
Total Annual Costs
$ 120,560
$ 101,967
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