Question

Current Designs is always working to identify ways to increase efficiency while becoming more environmentally conscious. During a recent brainstorming session, one employee suggested to Diane that the company should consider replacing the current rotomold over as a way to realize savings from reduced energy consumption. The oven operates on natural gas, using 30600 therms of natural gas for an entire year. A new energy efficient rotomold oven would operation on 2700 therms of natural gas for an entire year. After seeking out price quotes from a few suppliers, Diane determined that it would cost 450000 to purchase a new energy efficient rotomold oven. She determines that the expected useful life of the new oven would be 8 years, and it would have no salvage value at the end of its useful life. Current Designs would be able to sell the current oven for 18000.

a) Prepare an incremental analysis to determine whether to purchase the new rotomold oven assuming that the average price for natural gas over the next 8 years will be 0.78 per therm. Should they retain or replace? The prices are needed for the following: Variable manufacturing costs, New Oven Costs. Proceed with scrapping old oven, Total.

b) Diane is concerned that natural gas prices might increase at a faster rate over the next 8 years. If the company projects average has price of the 1.02 per therm, discuss how that might change your conclusion in (a). Should they retain or replace? The prices are needed for the following: Variable manufacturing costs, New Oven Costs, Proceed wit scrapping old oven, Total.

Answer 1

		IN OVEN
		Natural Gas Consumption	30,600	Therms
		NEW ENERGY ROTOMOLD OVEN	2,700	Therms
		Price for new oven	450,000
		Useful life	8 Years
		salvage value of current oven	18,000
	(a)	Average price	0.78	per therm
		Variable manufacturing cost	30600*.78
		under old oven	23,868
		Variable manufacturing cost	2700*.78
		under new oven	2,106
		Incremental cost
		new oven price	450,000
		Sales price for old oven	(18,000)
		Net Price for oven	432,000
		Per year price	432000/8
		Per year price	54,000
		Savings per year	23868-2106
		Savings per year	21,762
		Net extra outflow	54000-21762
		Net extra outflow/year	32,238
		As there will be extra outflow every year of 32238 so it is not
		advisable to go with new oven.
	(b)	Average price	1.02	per therm
		Variable manufacturing cost	30600*1.02
		under old oven	31,212
		Variable manufacturing cost	2700*1.02
		under new oven	2,754
		Incremental cost
		new oven price	450,000
		Sales price for old oven	(18,000)
		Net Price for oven	432,000
		Per year price	432000/8
		Per year price	54,000
		Savings per year	31212-2754
		Savings per year	28,458
		Net extra outflow	54000-28458
		Net extra outflow/year	25,542
		As there will be extra outflow every year of 25542 so it is not
		advisable to go with new oven.