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 8,000 ships: Direct materials $30,800 Direct labor 28,400 Variable overhead 13,200 Fixed overhead 34,400 Total $106,800 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 $40,000. 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 $2.05 per unit." Finley thinks this estimate is accurate, bnnut also knows that a higher quality of direct material will be necessary with the new equipment, costing $0.19 more per unit. Fixed overhead costs will decrease by $4,900. Finley expects production to be 8,600 ships in each of the next six years. Assume a discount rate of 5%. 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

In the Given situation, the Revenue component is missing. And so we can not compute the Net Present Value. Instead, we compute the PV of the total Costs.
Assumptions :-
The Depreciation Method used is SLM
There is no Profit/Loss on the Sale of Equipment at the end of the Period.
Cumulative PVF @ 05 % for 6 years = 5.0757
Cost Components under Old Machine
	Units = 8000	per unit cost	Remarks
Direct Material	30800	3.85		( = 30800/8000)
Direct Labour	28400	3.55
Vraiable OH	13200	1.65
Fixed OH	34400
Depreciation	20000			(200000/10 years)
	126800
PV of Costs	643599			(126800*5.0757)
Cost Components under New/Replaced Machine
	Units =8600	per unit cost	Remarks
Direct Material	34744	4.04		=3.85+0.19
Direct Labour and OH	27090	3.15		=3.55+1.65-2.05
Fixed OH	29500			=34400-4900
Depreciation	17500			(145000-40000)/6
	108834
	552409
Initial Investment	125000
Total Costs	677409
Cost of new equipment		145000
Less:- salvage of old Equipment		-20000
Net Initial Investment		125000
				33810
Solution :- the difference in NPV as per the costs is = 677409-643599 = 33810.