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 8,000 ships:

Direct materials	$29,600
Direct labor	29,600
Variable overhead	12,000
Fixed overhead	36,000
Total	$107,200

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 $45,000. 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 $2.25 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 $4,600.

Finley expects production to be 8,400 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

Initial investment :purchase cost of new equipment 150000-30000 resale value of old equipment

                = 120000

2)Incremental savings per year : unit sold [saving in labor and overhead - increased material cost ]- increase in fixed overhead

8400[2.25-.25]    -4600

   12200

Present value of annual cash flow :[PVA 3% ,4*Incremental savings]+[PVF 3%,4*Salvage value]

          =[3.71710*12200] + [ .88849*45000]

              = 45348.62+ 39982.05

             = 85330.67

difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment = Present value -Initial cost

         85330.67- 120000

        = -34669.33