Making Automation Decision
Soldrum Company is considering automating its production facility. The initial investment in automation would be $12 million, and the equipment has a useful life of 10 years with a residual value of $1 million. The company will use straight-line depreciation. Soldrum could expect a production increase of 40,000 units per year and a reduction of 20 percent in the labor cost per unit.
| Current (no automation) | Proposed (automation) | ||
| ||||
Production and sales volume | 80,000 units | 120,000 units | ||
| Per Unit | Total | Per Unit | Total |
Sales revenue | $90 | ? | $90 | ? |
Variable costs |
|
|
|
|
Direct materials | $18 |
| $18 |
|
Direct labor | 25 |
| ? |
|
Variable manufacturing overhead | 10 |
| 10 |
|
Total variable manufacturing costs | 53 |
| ? |
|
Contribution margin | $37 | ? | $42 | ? |
Fixed manufacturing costs |
| 1,250,000 |
| 2,350,000 |
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 10% discount rate.
6.Would you advise Soldrum to invest in the automation?
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