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 7,600 ships:

Direct materials	$27,740
Direct labor	28,500
Variable overhead	14,060
Fixed overhead	33,060
Total	$103,360

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 $2.00 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 $0.21 more per unit. Fixed overhead costs will increase by $4,300.

Finley expects production to be 8,200 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

Statement showing NPV

Particulars	0	1	2	3	4	NPV
Cost of equipment(140000-30000)	-110000
Savings in Variable and overhead cost (2*8200)		16400	16400	16400	16400
Extra cost of Direct material(0.21*8200)		-1722	-1722	-1722	-1722
Increase in fixed cost		-4300	-4300	-4300	-4300
Salvage value of new machine					45000
Total cash flow	-110000	10378	10378	10378	55378
PVIF @ 3%	1	0.9709	0.9426	0.9151	0.8885
Present value	-110000	10075.7282	9782.26	9497.34	49202.64	-31442

Thus new ship should not be purchased