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 $30,000. The following are last year's total manufacturing costs, when production was 9,000 ships:

Direct materials $34,650

Direct labor 31,500

Variable overhead 16,200

Fixed overhead 41,850

Total $124,200

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 $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 $1.90 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 $5,000.

Finley expects production to be 9,550 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

Computation of Net Present Value are as follows:-

	Particulars	1	2	3	4
	Net Savings*	10,758	10,758	10,758	10,758
	Salvage Value				40,000
	Total Cash Inflows/Savings	10,758	10,758	10,758	50,758
	PV Factor	0.9709	0.9426	0.9151	0.8885
	Present Value of cash flows	10,444	10,140	9,844	45,098
	Total PV of cash flows/Savings	75,527
	Less:- Initial Invenstment	(150,000)
	Net Present Value	(74,473)
*
Particulars	Purchase of new equipment	Current Cost	Saving
Direct Material & Labor cost	54,435	70,193	15,758
Increase in Fixed cost	46,850	41,850	(5,000)
Net Savings			10,758
As Net Present Value is negative so purchase of new equipment is not proposed