Nautical Creations is one of the largest producers of miniature ships in a bottl

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 2012 for $200,000. It is now early in 2015, 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 $20,000. The following are last year's per-unit manufacturing costs, when production was 8,400 ships:

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 to be reduced by $2.05 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 $0.19 more per unit. Fixed overhead costs will decrease by $3,700.

Finley expects production to increase to 8,850 ships in each of the next six years. Assume a discount rate of 3%.

1.What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?

Direct materials $3.80 Direct labor 3.60 Variable overhead 1.80 Fixed overhead 4.70 Total unit cost $13.90

Explanation / Answer

Answer:

Working 1:

Inflows if old equipment sold immediately Amount$ Saving in direct labor and variable overhead(2.05*8850)      18,142.50 Less: Additional cost of direct material(0.19*8850)      (1,681.50) Add: Saving in Fixed Costs        3,700.00 Total inflow per year for 6 years      20,161.00 Present value of inflows(Please see working 1)    109,216.00 Outflows if old equipment sold immediately Amount$ Cost of new equipment    140,000.00 Less: Sale of current equipment    (20,000.00) Less: Present value of disposal @3%- 40000(1/(1+.03)^6)    (33,500.00) Present value of Outflow      86,500.00 Net Present Value( Present values of inflows- outflows)      22,716.00

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