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 four more years with zero disposal value at that time. It can be sold immediately for $30,000. The following are last year's total manufacturing costs, when production was 7,600 ships:

Direct materials $27,360

Direct labor 27,740

Variable overhead 12,920

Fixed overhead 35,340

Total $103,360

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 $2.20 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 increase by $3,700. Finley expects production to be 8,200 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

Caluclation of Diffrential NPV if nautical creation buys the equipment
Year	Cash Inflow/(Outflow)	PV Factor @3%	Present value	Remarks for cash flow column
0	(120,000)	1.000	(120,000)	(=New Equipment cost $150000- salvage value of old equipment $30000 = 120000)
1	12,290	0.971	11,932	(Saving in material cost - excess material cost )* No. of ships produced - Excess fixed overhead ; (2.2-0.25)*8200 -3700
2	12,290	0.943	11,585	(Saving in material cost - excess material cost )* No. of ships produced - Excess fixed overhead ; (2.2-0.25)*8200 -3700
3	12,290	0.915	11,247	(Saving in material cost - excess material cost )* No. of ships produced - Excess fixed overhead ; (2.2-0.25)*8200 -3700
4	12,290	0.888	10,920	(Saving in material cost - excess material cost )* No. of ships produced - Excess fixed overhead ; (2.2-0.25)*8200 -3700
4	50,000	0.888	44,424	salvage value of new equipment
	Net Present Value	(29,893)
	NPV = -29893