Making Automation Decision
Praton Company is considering automating its production facility. The initial investment in automation would be $8,000,000 and the equipment has a useful life of eight years with a residual value of $1,500,000. The company will use straight-line depreciation. Praton could expect a production increase of 20,000 units per year and a reduction of 40 percent in the labor cost per unit.
| Current (no automation) | Proposed (automation) | ||
| ||||
Production and sales volume | 60,000 units | 80,000 units | ||
| Per Unit | Total | Per Unit | Total |
Sales revenue | $70 | ? | $70 | ? |
Variable costs |
|
|
|
|
Direct materials | $15 |
| $15 |
|
Direct labor | 20 |
| ? |
|
Variable manufacturing overhead | 7 |
| 7 |
|
Total variable manufacturing costs | 42 |
| ? |
|
Contribution margin | $28 | ? | $36 | ? |
Fixed manufacturing costs |
| 800,000 |
| 1,612,500 |
Net income |
| ? |
| ? |
Required:
1.Complete the preceding table showing the totals and summarize the difference in the alternatives.
2.Determine the project’s accounting rate of return.
3.Determine the project’s payback period.
4.Using a discount rate of 15 percent, calculate the net present value (NPV) of the proposed investment.
5.Recalculate the NPV using a discount rate of 10 percent.
6.Would you advise Praton to invest in the automation?
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