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 2016 for $200,000. It is now early in 2020, 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 $20,000. The following are last year's total manufacturing costs, when production was 7,600 ships: Direct materials Direct labor Variable overhead $28,880 28,120 12,540 34,580 $104,120 Fixed overhead Total The cost of the new equipment is $145,000. It has a four year useful life with an estimated disposal value at that time of $50,000. 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 $1.90 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 $0.25 more per unit. Fixed overhead costs will increase by $3,900. Finley expects production to be 8,150 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? || Submit Answer Incorrect. Tries 4/8 Previous Tries

Answer 1

Description Direct material Direct labor Variable overhead Fixed overhead Existing machine New machine Calculations Amount ($) Calculations ($28,880/7,600) x 8,150 30970 [($28,880/7,600) +0.25] x 8,150 ($28,120/7,600) x 8,150 30155 ($28,120/7,600) x 8,150 ($12,540/7,600) x 8,150 13447.5 ($12,540/7,600) X 8,150 34580 ($34,580 + $3,900) Amount ($) 30970.25 30155 13447.5 38480 ($1.9 x 8,150) Less: Direct labor and variable overhead reduction Total cost Saving in cost ($109,152.5 - $97,567.75) - 15485 97567.75 109152.5 11584.75

New machine Cash flow (A) 0 -$145,000 + $20,000 1 $11,584.75 2 $11,584.75 3 $11,584.75 4 $11,584.75 + $50,000 Net present value Present PVF @ 3% (B)value (AXB) - 125000 0.970873786 11247.3301 0.942595909 10919.73796 0.915141659 10601.68734 0.888487048 54717.25272 -37513.9919

Hence, difference in NPV is $37,514.