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 six more years with zero disposal value at that time. It can be sold immediately for $40,000. The following are last year's total manufacturing costs, when production was 8,000 ships:

Direct materials	$29,200
Direct labor	30,400
Variable overhead	12,000
Fixed overhead	37,600
Total	$109,200

The cost of the new equipment is $140,000. It has a six year useful life with an estimated disposal value at that time of $40,000. 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 $0.23 more per unit. Fixed overhead costs will decrease by $4,800.

Finley expects production to be 8,550 ships in each of the next six years. Assume a discount rate of 5%.

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

	EXISTING EQUIPMENT	New Equipment	Difference	Present value /Annuity factor	Diference in NPV
Initial investment	0	-140,000	-140,000	1	-140,000
Operating cash out flow	102,366	83,288	19,079	5	96,842
Scap value old Equipment	0	40,000	40,000	1	40,000
Scrap value of new machine	0	40,000	40,000	1	29,840
					26,682
So new machine purchase will give more NPV of $26,682
For operative cash flow the Annuity factor for 6 years @ 5% applicable
For Scrap value the present value factor for 6 years @ 5% applicable

CALCULATION OF SAVING IN OPERATIVE CASH OUTFLOW
	EXISTING EQUIPMENT	NEW EQUIPMENT
	8000 units	Per unit	8550 Units	Per unit	8550 Units
Direct mateirlas	29,200	4	31,208	4	33,174
Direct labour & Variable overhead	31,400	4	33,559	2	17,314
Fixed overhead	37,600		37,600		32,800
TOTAL			102,366		83,288