This is a decision to keep or replace current equipment, mutually exclusive alte
ID: 2450073 • Letter: T
Question
This is a decision to keep or replace current equipment, mutually exclusive alternatives. The question asks for the difference in the net present values of the two alternatives, not the net present value of one or the other. Use the present value tables on page 118 to compute present values. 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 four more years with zero disposal value at that time. It can be sold immediately for $30,000. The following are last year's per-unit manufacturing costs, when production was 8,800 ships: The cost of the new equipment is $135,000. It has a four year useful life with an estimated disposal value at that time of $45,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead 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 $0.21 more per unit. Fixed overhead costs will increase by $3,000. Finley expects production to increase to 9,250 ships in each of the next four years. Assume a discount rate of 3%. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?Explanation / Answer
Ans-
Calculation of total cost under old equipment
Direct material 3.6
Direct labour 3.6
Variable overhead 1.65
Fixed overhead 4.3
Total cost $13.15
Total cost of 8800 units(8800*13.15)$115720
Add-depreciation(200000-30000/4) $42500
Total cost $158220
Net present value @3% for 4 years
PV of Total cost for 4 years(158220*3.716) $587946
Less-PV of net realisable value(30000*0.888) $26640
Net present value $561306
Calculation of total cost Under new equipment
Direct material 3.6
Direct labour 3.6
Variable overhead 1.65
Fixed overhead 4.3
Total cost(13.15-1.9+0.21)$11.46
Total cost of 9250units (9250*11.46)$106005
Add-Depreciation(135000-45000/4) $22500
Fixed overhead $3000
Total cost $131505
Net present value @3% for 4 years
PV of Total cost for 4 years(131505*3.716) $488673
Less-PV of net realisable value(45000*0.888) $39960
Net present value $448713
Difference in net present value(561306-448713)$112593
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