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 2015 for $200,000. It is now early in 2019, 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 $30,000. The following are last year's total manufacturing costs, when production was 8,800 ships: Direct materials $33,880 Direct labor 32,120 Variable overhead 14,520 Fixed overhead 40,040 Total $120,560 The cost of the new equipment is $145,000. 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 $2.05 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 $0.19 more per unit. Fixed overhead costs will decrease by $3,100. Finley expects production to be 9,200 ships in each of the next six 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

Cash Inflow
	Decrease in direct labor and variable overhead per unit	$            2.05
Less:	Increase in direct material per unit	$            0.19
	Net Decrease in Variable cost per unit	$            1.86
Multiply:	Expected Production per year	9,200
	Decrease in Total Variable Cost	$       17,112
Add:	Decrease in Fixed overhead	$          3,100
	Decrease In Total Cost per year	$       20,212
	Cash Saving Each year (Decrease In Total Cost per year)	$       20,212
	Estimated disposal value at end of sixth year	$       35,000
Cash Outflow
	Cost of the new equipment	$     145,000
Less:	Sold of the old equipment	$       30,000
	Net Cash Outflow or Net Investment	$     115,000

Year 6 Cash flow = 20212+35000 = 55212
Year	Cash Flow	Discount Factor @ 3%	Present Value
0	$       (115,000)	1.00000	$       (115,000)
1	$            20,212	0.970874	$      19,623.30
2	$            20,212	0.942596	$      19,051.75
3	$            20,212	0.915142	$      18,496.84
4	$            20,212	0.888487	$      17,958.10
5	$            20,212	0.862609	$      17,435.05
6	$            55,212	0.837484	$      46,239.18
Net Present Value			$      23,804.22
Difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment			$      23,804.22
Advice: Nautical Creations should buy new equipment instead of keeping their current equipment. Because it has a Positive net present value.