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 2016 for $200,000. It is now early in 2020, 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 $20,000. The following are last year's total manufacturing costs, when production was 7,400 ships:

Direct materials	$28,860
Direct labor	28,490
Variable overhead	12,580
Fixed overhead	34,040
Total	$103,970

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 $35,000. 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 $2.15 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 decrease by $4,300.

Finley expects production to be 8,000 ships in each of the next six years. Assume a discount rate of 5%.

What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?

Answer 1

Calculation of Differnce in NPV
Buys the New Equipment Instead of Current Equipment
Particulars	Year	5% Factor	Net Cash Flow	Present value
			C	C X D
		D
Cash Inflow
Savings in Direct Labor & Varaible Cost - $2.15 X 8,000Units	1-6	5.07569	17200	87,302
Savings in Fixed Cost	1-6	5.07569	4,300	21,825
Salvage Value of Old Machine	0	1.00000	20,000	20,000
Sakavage Value of New Machine	6	0.74622	35,000	26,118
A. Total Cash Inflow - PV				155,245
Cash Outflow
Cost of New Machine	0	1.00000	145,000	145,000
Increase in Cost of Material Cost - $0.25 X 8,000 Units	1-6	5.07569	2,000	10,151
B. Total Cash Outflow - PV				155,151
Differnce in NPV (A - B)				94