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 $35,000. The following are last year's total manufacturing costs, when production was 7,600 ships:

Direct materials	$28,500
Direct labor	26,600
Variable overhead	13,300
Fixed overhead	35,720
Total	$104,120

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 $50,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead 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 $0.15 more per unit. Fixed overhead costs will increase by $3,200.

Finley expects production to be 8,000 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?

Answer 1

Present Cost
Units	7600
Direct Material	$3.75
Direct Labor	$3.50
Variable overhead	$1.75
Total Variable cost	$9.00	$68,400
Fixed costs		$35,720
Total Costs	$13.70	$104,120
Proposed Cost
Units	8000
Direct Material	$3.90
Direct Labor	$1.35
Variable overhead	$1.50
Total Variable cost	$6.75	$54,000
Fixed costs		$38,920
Total Costs	$11.62	$92,920
Saving in costs - per unit	$2.09
Total Saving in cost - per year	$11,200
Computation of present Value of new Machinery
Year	Cash flow	PV Factor	Present value
0	-115000	1	-115000
1	$11,200	0.97087379	10873.79
2	$11,200	0.94259591	10557.07
3	$11,200	0.91514166	10249.59
4	$11,200	0.88848705	9951.055
4	$50,000	0.88848705	44424.35
Net Present Valaue			($28,944)
Since the net present value of new machine is negaive 28944, the proposal cannot be accepted.