Saxon Products, Inc., is investigating the purchase of a robot for use on the company’s assembly line. Selected data relating to the robot are provided below:
Cost of the robot | $1,400,000 |
Installation and software | $470,000 |
Annual savings in labor costs | ? |
Annual savings in inventory carrying costs | $210,000 |
Monthly increase in power and maintenance costs | $2,000 |
Salvage value in 5 years | $86,000 |
Useful life | 5 years |
Engineering studies suggest that use of the robot will result in a savings of 20,000 direct labor-hours each year. The labor rate is $8 per hour. Also, the smoother work flow made possible by the use of automation will allow the company to reduce the amount of inventory on hand by $360,000. This inventory reduction will take place at the end of the first year of operation; the released funds will be available for use elsewhere in the company. Saxon Products has a 12% required rate of return.
Shelly Martins, the controller, has noted that all of Saxon’s competitors are automating their plants. She is pessimistic, however, about whether Saxon’s management will allow it to automate. In preparing the proposal for the robot, she stated to a colleague, “Let’s just hope that reduced labor and inventory costs can justify the purchase of this automated equipment. Otherwise, we’ll never get it. You know how the president feels about equipment paying for itself out of reduced costs.”
Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. Determine the annual net cost savings if the robot is purchased. (Do not include the $360,000 inventory reduction or the salvage value in this computation.)
Savings in labor costs:
Savings in inventory carrying costs:
Total:
Less increased power and maintenance cost:
Annual net cost savings :
2-a. Compute the net present value of the proposed investment in the robot. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.)
=======================NOW----------1--------2----------3-------4-------5
Cost of the robot
Installation and software
Annual net cost savings
Inventory reduction
Salvage value (old)
Discount factor 12%
Present value
Net present value
2-b. Based on these data, would you recommend that the robot be
purchased?
Yes | |
No |
3-a. Assume that the robot is purchased. At the end of the first
year, Shelly Martins has found that some items didn’t work out as
planned. Due to unforeseen problems, software and installation
costs were $130,000 more than estimated and direct labor has been
reduced by only 9,000 hours per year, rather than by 20,000 hours.
Assuming that all other cost data were accurate. Show computations
using the net present value format as in (2) above. (Hint: It might
be helpful to place yourself back at the beginning of the first
year with the new data.) (Any cash outflows should be
indicated by a minus sign. Round discount factor(s) to 3 decimal
places.)
=======================NOW----------1--------2----------3-------4-------5
Cost of the robot
Installation and software
Annual net cost savings
Inventory reduction
Salvage value (old)
Discount factor 12%
Present value
Net present value
4-b. Based on your analysis in Requirement 3
above, compute for the president the dollar amount of cash inflow
that would be needed each year from the benefits in (a) above in
order for the equipment to yield a 12% rate of return.
(Round discount factor to 3 decimal places. Enter all
amount as positive values.)
Choose Numerator ---------------------------------- Choose Denominator
Negative net present value to be offset / Present value factor, 5 years at 12%=CASH inflow
________________________________ / _________________________________
Savings in Direct labor | $ 160,000.00 |
Savings in inventory Costs | $ 210,000.00 |
Less : Annual increase in power and maintenance | $ 24,000.00 |
Annual Net cost Savings | $ 346,000.00 |
Year | Annual Savings | Inventory Reduction | Salvage Value | Total Cash Flows | PV @12% | PV |
1 | $ 346,000 | $ 360,000 | $ 706,000 | 0.8929 | $ 630,357 | |
2 | $ 346,000 | $ 346,000 | 0.7972 | $ 275,829 | ||
3 | $ 346,000 | $ 346,000 | 0.7118 | $ 246,276 | ||
4 | $ 346,000 | $ 346,000 | 0.6355 | $ 219,889 | ||
5 | $ 346,000 | $ 86,000 | $ 432,000 | 0.5674 | $ 245,128 | |
Total PV | $ 1,617,480 | |||||
Investment | $ 1,870,000 | |||||
NPV | $ (252,520) |
Since project has negative NPV, it will not be accepted.
Year | Annual Savings | Inventory Reduction | Salvage Value | Total Cash Flows | PV @12% | PV | |
1 | $ 258,000 | $ 360,000 | $ 618,000 | 0.8929 | $ 551,786 | $ 321,429 | |
2 | $ 258,000 | $ 258,000 | 0.7972 | $ 205,676 | |||
3 | $ 258,000 | $ 258,000 | 0.7118 | $ 183,639 | |||
4 | $ 258,000 | $ 258,000 | 0.6355 | $ 163,964 | |||
5 | $ 258,000 | $ 86,000 | $ 344,000 | 0.5674 | $ 195,195 | 48798.70959 | |
Total PV | $ 1,300,260 | ||||||
Investment | $ 2,000,000 | $ 1,624,457 | |||||
NPV | $ (699,740) | 531284.9948 |
Savings in Direct labor | $ 72,000.00 |
Savings in inventory Costs | $ 210,000.00 |
Less : Annual increase in power and maintenance | $ 24,000.00 |
Annual Net cost Savings | $ 258,000.00 |
4b . Minimum cash flow required, NPV is set to zero
NPV = X x 3.6048 + $360000 x 0.8929 + $86000 x 0.5674 -
$2000000
0 = 3.6048x - 1629773
x = $452112
Minimum Cash flow required = $452112
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