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 $40,000. The following are last year's total manufacturing costs, when production was 7,600 ships:
| Direct materials | $27,360 |
| Direct labor | 27,360 |
| Variable overhead | 12,920 |
| Fixed overhead | 32,680 |
| Total | $100,320 |
The cost of the new equipment is $140,000. 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 $2.05 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 $0.23 more per unit. Fixed overhead costs will increase by $4,000.
Finley expects production to be 8,050 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?
Statement showing NPV
| Particulars | 0 | 1 | 2 | 3 | 4 | NPV |
| Cost of equipment(140000-40000) | -100000 | |||||
| Savings in Variable and overhead cost (2.05*8050) | 16502.5 | 16502.5 | 16502.5 | 16502.5 | ||
| Extra cost of Direct material(0.23*8050) | -1851.5 | -1851.5 | -1851.5 | -1851.5 | ||
| Increase in fixed cost | -4000 | -4000 | -4000 | -4000 | ||
| Salvage value of new machine | 45000 | |||||
| Total cash flow | -100000 | 10651 | 10651 | 10651 | 55651 | |
| PVIF @ 3% | 1 | 0.9709 | 0.9426 | 0.9151 | 0.8885 | |
| Present value | -100000 | 10341.056 | 10039.6 | 9746.73 | 49445.9 | -20426.67 |
Thus new ship should not be purchased
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