\"I\'m not sure we should lay out $265,000 for that automated welding machine,\"
ID: 2484037 • Letter: #
Question
"I'm not sure we should lay out $265,000 for that automated welding machine," said Jim Alder, president of the Superior Equipment Company. "That's a lot of money, and it would cost us $78,000 for software and installation, and another $3,400 every month just to maintain the thing. In addition, the manufacturer admits that it would cost $41,000 more at the end of three years to replace worn-out parts." "I admit it's a lot of money," said Franci Rogers, the controller. "But you know the turnover problem we've had with the welding crew. This machine would replace six welders at a cost savings of $108,000 per year. And we would save another $6,900 per year in reduced material waste. When you figure that the automated welder would last for six years, I'm sure the return would be greater than our 19% required rate of return." "I'm still not convinced," countered Mr. Alder. "We can only get $14,000 scrap value out of our old welding equipment if we sell it now, and in six years the new machine will only be worth $24,000 for parts. But have your people work up the figures and we'll talk about them at the executive committee meeting tomorrow." Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Compute the annual net cost savings promised by the automated welding machine.Explanation / Answer
1.
Reduction on labor cost
$ 108,000.00
Reduction on material waste
$ 6,900.00
Total
$ 114,900.00
Less increased maintenance cost
$ (40,800.00)
Annual net cost savings
$ 74,100.00
2.a
Now
1
2
3
4
5
6
Cost of machine
$ (265,000.00)
Software and installation
$ (78,000.00)
Salvage value of old equipment
$ 14,000.00
Annual net cost savings
$ 74,100.00
$ 74,100.00
$ 74,100.00
$ 74,100.00
$ 74,100.00
$ 74,100.00
Replacement of parts
$ (41,000.00)
Salvage value of new machine
$ 24,000.00
Total cash flow
$ (329,000.00)
$ 74,100.00
$ 74,100.00
$ 33,100.00
$ 74,100.00
$ 74,100.00
$ 98,100.00
Discount factor (19%)
$ 1.00
$ 0.84
$ 0.71
$ 0.59
$ 0.50
$ 0.42
$ 0.35
Present value
$ (329,000.00)
$ 62,268.91
$ 52,326.81
$ 19,642.06
$ 36,951.35
$ 31,051.56
$ 34,545.16
Net present value
$ (92,214.14)
b. As there is negative value of NPV ,automatic welding machine is not recommended.
Answer: No
Reduction on labor cost
$ 108,000.00
Reduction on material waste
$ 6,900.00
Total
$ 114,900.00
Less increased maintenance cost
$ (40,800.00)
Annual net cost savings
$ 74,100.00
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