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 six more years with zero disposal value at that time. It can be sold immediately for $35,000. The following are last year's total manufacturing costs, when production was 8,800 ships Direct materials$34,320 Direct labor 31,680 Variable overhead 14,960 Fixed overhead 40,040 Total$121,000 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 $30,000. 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 $2.00 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 $0.15 more per unit. Fixed overhead costs will decrease by $3,300 Finley expects production to be 9,400 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

Saving in variable cost per unit (net) Saving in laour andd overheads 2 Less: Additional material required cost: 0.15 Net saving per unit 1.85 Number of Units expected to produce 9400 Annual Savings 17390 Add: Decrease in fixed Cost 3300 Nnet Annual savings 20690 Present value of Net savings in cost for six years 112082 ($ 20690*Present Annuity factor i.e.5.4172) Present value of salvage value at end of Year-6 25125 ($ 30000* PVF of Year-6 i.e. 0.0.8375) Total Present values of Inflows 137207 Initial Investment 145000 Less: Realisable value of Old plant 35000 110000 Incremental Net present Value 27207

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