Saxon Products, Inc., is investigating the purchase of a robot for use on the co

Question

Saxon Products, Inc., is investigating the purchase of a robot for use on the company’s assembly line. Selected data relating to the robot are provided below:

    Cost of the robot $1,600,000 Installation and software $450,000 Annual savings in labor costs ? Annual savings in inventory carrying costs $210,000 Monthly increase in power and maintenance costs $2,500 Salvage value in 5 years $70,000 Useful life 5 years

Engineering studies suggest that use of the robot will result in a savings of 25,000 direct labor-hours each year. The labor rate is $16 per hour. Also, the smoother work flow made possible by the use of automation will allow the company to reduce the amount of inventory on hand by $400,000. This inventory reduction will take place at the end of the first year of operation; the released funds will be available for use elsewhere in the company. Saxon Products has a 20% required rate of return.

Shelly Martins, the controller, has noted that all of Saxon’s competitors are automating their plants. She is pessimistic, however, about whether Saxon’s management will allow it to automate. In preparing the proposal for the robot, she stated to a colleague, “Let’s just hope that reduced labor and inventory costs can justify the purchase of this automated equipment. Otherwise, we’ll never get it. You know how the president feels about equipment paying for itself out of reduced costs.”

Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Determine the annual net cost savings if the robot is purchased. (Do not include the $400,000 inventory reduction or the salvage value in this computation.)

Explanation / Answer

Inflow Saving in Inventory Carrying cost $     210,000 Inflow Saving in 25000 Direct Labour Hours $16 per Hour $     400,000 Inflow Reduction of Inventory on Hand - Not to be considered $                 -   Inflow Salvage Value of Robot - Not to be considered $                 -   Total Inflow per Year $     610,000 5 Year Annuity Factor @ 20%            2.9910 A Present Value of Saving in 5 Years $ 1,824,510 Outflow Power & Maintenance Expenses per Month $          2,500 Total Outflow per Year $          2,500 60 Month Annuity Factor @ 1.6667%          37.7446 (i) Present Value of Outflow in 5 Years $        94,362 Cost of Robot $ 1,600,000 Installation & Software $     450,000 (ii) Total cost in 0th Year $ 2,050,000 B Total Outflow for Robot i + ii $ 2,144,362 Net Loss if Robot is Purchased ( A - B) $   (319,852)

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