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 six more years with zero disposal value at that time. It can be sold immediately for $25,000. The following are last year's total manufacturing costs, when production was 8,600 ships:

Direct materials	$32,250
Direct labor	32,250
Variable overhead	15,910
Fixed overhead	37,410
Total	$117,820

The cost of the new equipment is $130,000. It has a six year useful life with an estimated disposal value at that time of $35,000. 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 $2.10 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 $0.19 more per unit. Fixed overhead costs will decrease by $4,900.

Finley expects production to be 9,200 ships in each of the next six years. Assume a discount rate of 3%.

What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment? *please show step-by-step so I can see what it is I am doing wrong!

Answer 1

1)Depreciation On new Equipment : [cost -salvage ]/useful life

            =[130000-35000]/6

            =15833.33

2)Annual saving /(cost )= Number of units [saving in labor and overhead -material ]+ saving in fixed overhead

               = 9200 [2.1 -.19] +4900

               = 17572+4900

               = 22472

**Depreciation is irrelevant as tax rate is not given .

3)Present value of cash flow : [PVA 3%,6 *Annual cash flow ] +[PVF 3%,6*Salvage]

              =[5.41719*22472]+ [.83748*35000]

               = 121735.09+ 29311.8

                = 151046.89

4)Initial investment : 130000- 25000 (Disposal value of old equipment)

           = 105000

NPV =Present value -Initial cost

        = 151046.89 - 105000

       = $ 46046.89