Question

Saxon Products, Inc., is investigating the purchase of a robot for use on the company’s assembly line. Selected data relating to the robot are provided below:

Cost of the robot	$	1,550,000
Installation and software	$	405,000
Annual savings in inventory carrying costs	$	222,000
Annual increase in power and maintenance costs	$	42,000
Salvage value in 5 years	$	71,000
Useful life		5	years

Engineering studies suggest that use of the robot will result in a savings of 23,000 direct labor-hours each year. The labor rate is $18 per hour. Also, the smoother work flow made possible by the use of automation will allow the company to reduce the amount of inventory on hand by $412,000. This inventory reduction will take place at the end of the first year of operation; the released funds will be available for use elsewhere in the company. Saxon Products has a 23% required rate of return.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Determine the annual net cost savings if the robot is purchased. (Do not include the $412,000 inventory reduction or the salvage value in this computation.)

2-a. Compute the net present value of the proposed investment in the robot.

2-b. Based on these data, would you recommend that the robot be purchased?

3-a. Assume that the robot is purchased. However, due to unforeseen problems, software and installation costs were $87,000 more than estimated and direct labor could only be reduced by 18,500 hours per year, rather than the original estimate of 23,000 hours. Assuming that all other cost data is accurate, what would a postaudit suggest is the actual net present value of this investment?

3-b. Does it appear that the company made a wise investment?

4-a. Which of the following are intangible benefits associated with the new automated equipment?

4-b. Based on your analysis in Requirement 3 above, compute for the president the minimum dollar amount of annual cash inflow that would be needed from the benefits in part 4(a) for the automated equipment to yield a 23% rate of return.

Answer 1

1.Annual net cost savings if the robot is purchased

Cost Saved
Annual savings in inventory carrying costs	$222000
Direct labor cos(23000*18/hr)	$414000
Total savings	$636000

2a NPV

cost
cost of the Robot	1550000
Installation	405000
Total cost	1955000
Depreciation per annum (1955000-71000)/5years)	376800

Outflow	initial investment	Year 1	Year2	Year3	Year4	Year 5
Initial cost	1955000
Increase in power per annum		42000	42000	42000	42000	42000
Total (B)	1955000	42000	42000	42000	42000	42000
Inflow
Annual savings in inventory		222000	22000	222000	222000	222000
Labor cost savings		414000	414000	414000	414000	414000
Inventory holding cost savings		412000
Total		1048000	636000	636000	636000	636000
(A-B)Net cash flow	(1955000)	1006000	594000	594000	594000	594000
Discount factor @23%	0	.813	.661	.537	.437	.355
Discounted cash flows	(1955000)	817878	392634	318978	259578	210870

so Npv =1999938-1955000 =44938

2b)Since NPV is positive we accept the proposal

3a

Outflow	initial investment	Year 1	Year2	Year3	Year4	Year 5
Initial cost	1955000+87000
Increase in power per annum		42000	42000	42000	42000	42000
Total (B)	2042000	42000	42000	42000	42000	42000
Inflow
Annual savings in inventory		222000	222000	222000	222000	222000
Labor cost savings(18500*18)		333000	333000	333000	333000	333000
Inventory holding cost savings		412000
Total		967000	555000	555000	555000	555000
(A-B)Net cash flow	(2042000)	925000	513000	513000	513000	513000
Discount factor @23%	0	.813	.661	.537	.437	.355
Discounted cash flows	(2042000)	752025	339093	275481	224181	182115

so Npv =1772895-2042000 =-269105

3b) No, Here the decision of company was wrong because here NPV is negetive