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 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 $0.15 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

Hi i think this answer might be useful

Two step process

S1 computaition of Present value of incremental cash out flow

I) Net cash out flow when we pruchase new asset in place of old = 115,000    (1,50,000(new)-35000(sale of old))

     less present value of terminal value of asset in 4 years           =44424    pv factor (4y.3%)*50,000

Net cash out flow                                                                  =70576    (115000-44424)

S2) Incremental cash inflow

a) net incremental revenue from saving in labour overhead and mat=16000          <2*8000units > (2.15-.0.15)

b) incremental fixed cost                                                           =(3200)            -ve

Net incremental cash inflow                                                      =12800             p.v anuity factor (4Y, 3%)=3.7171

Net p.v of incremental cash inflow(12800*3.7171)                       =47579

S3) net value= S2-S1= 47579-70576=(22997) as there is -ve cash flows its not viable to accept the project. so its not viable to purchase new equipment .