A company is considering replacing an unsafe manual operation with a robot. The

Question

A company is considering replacing an unsafe manual operation with a robot. The robot purchase and installation cost is $170,000 and annual operating expense is $15,000. The manual system has annual operating expenses of $65,000. Equipment used with the manual system could be sold at a salvage value of $30,000.

a. What is the rate of return for the robotics system?

b. What is the payback for the robotics system.?

c. It is hard to determine the dollar value in terms of safety improvement. If the required rate of return for the organization is 40%, what is the implied annual value of the safety if the company implements the robot?

Explanation / Answer

Robotic System Installation Cost = $170,000

Salvage value of Manual System = $30,000 (Assuming that manual system can be sold immediately)

So, Net initial investent = $170,000 - $30,000 = $140,000

Annual Operating expenses with Manual Systems = $65,000

Annual Operating expenses with Robotic System = $15,000

Annual Savings on Operating expenses by replacing Manual System with Robotic System = $65,000 - $15,000 = $50,000

1. Rate of Return = Savings/Initial Investment = $50,000/$140,000 = 35.71%

2. Payback period = $140,000/$50,000 = 2.8 years

3. Implied Annual Value of safety improvement if company implements the robotic system = 40%*$140,000 = $56,000 (Here, we have taken $140,000 as the investment and not $170,000 since safety improvement is due to the implementation of the robotic system where errors due to manual systems would be avoided and hence safety would be improved). Hence, implied value of safety = required return on the initial investment. (Assuming $140,000 as the investment and not $170,000.)

PS: You can even assume $170,000 as the investment for calculating Payback and Safety ans provide reasons accordingly. I have not assumed that and I have assumed it after reducing the salvage value from the investment required for robotic systems.

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