Nautical Creations is one of the largest producers of miniature ships in a bottl
ID: 2557334 • Letter: N
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 2013 for $200,000. It is now early in 2017, 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 total manufacturing costs, when production was 8,200 ships:
The cost of the new equipment is $150,000. It has a four 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 $2.20 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 $3,400.
Finley expects production to be 8,800 ships in each of the next four years. Assume a discount rate of 5%.
1. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?
Direct materials $31,980 Direct labor 29,110 Variable overhead 14,760 Fixed overhead 37,720 Total $113,570Explanation / Answer
Net Annual savings in cost: Saving in variable cost: Labour anad overheads 2.2 Less: Increase in Material 0.21 Net savings per unit 1.99 Number of produced 8800 Savings in variable cost 17512 Les: Increase in Fixed cost -3400 Net Annual savings in cost: 14112 Present value of Cash inflows: Present value of Annual savings for 4 years 50041 ($ 14112 *Annuity factor for years4 i.e. 3.546) Present value of Salvage value 32908 ($ 40,000 *PVF at year-4 i.e. 0.8227) Total Present value of Inflows 82949 Present value of outflows: Initial investment 150000 Less: Disposal value of old equipment 30000 Present value of outflows: -120000 Net Present value -37051
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