Mavis Machine Shop* . The case is set in o metalworking job shop in West Virginia, one of whose products ts drill bitsfor oil exploration. The time is 1980, in the rum ofan oil drilling boom resaltingom the oil crises of}??? and 1979 ' Early in 1980, Tom Mavis, President of Mavis Machine Shop was considering a project to modernize his plant facilities. The company operated out of a large converted warehouse in Salem, West Virginia. It produced_ assorted machined metal parts for the oil and gas drilling and production industry in the surrounding area. One of Man's' major customers was Buckeye Drilling. Inc\" which purchased specialized drill bits and replacement parts for Its operations Mavis had negotiated on annual contract with Buckeye to supply its drill bit requirements and related spare parts in each of the past 8 years. In 1978 and 19?? the requirements had been about 8 .400 bits per year All Buckeye s rigs were busy. Mavis loaew there were 30 rigs operating in the state in 1979,i1p from 1'? in 1972 Wells drilled was up even more, from 6?9 m 1972 to 1,474 last year. _ The arrangement of the machine shop included four large ntanual ladies amend}! devoted, to the Buckeye business Each lathe was operated by a skilled worker, and each bit required machining at all four lathes. Mavis was considering replacing these manual Iathes with an automatic machine, capable of performing all four machining operations necessary for a drill bit. This machine would produce drill hits at the same rate as the four existing lathes, and would only require one operator. Instead of skill" in metalworking, the job would now involve more skill in computerized automation. The four existing manual lathes were 3 years old andhad cost a total of $59{l ,000- Together theyr could produce 8 ,400 drill bits on a two-shift, 5-dayfweek basis. The useful life of these ladies, ' calculated on a two-shiftfday, Sudayfweek basis, was estimated to he 15 years. The salvage value at the end of their useful life was estimated to be $5,000 each. Depreciation of $1l4,000 had been accumulated on the four Iath'es. Cash for the purchase of these 13th=s had been parlially supplied by a 10.311221; unsecured, 10% bank loan, of Which $180,000 was still amending. rue best estimate of the current selling price of the four'lathes in their present condition was $240,000, after dismantling and removal costs. The loss Eton: the sale would be deductible for tax purposes, resulting in a tax savings of 46% of the loss. ' The automatic machine being considered needed only one skilled operator to feed in raw castings, observe 1ts functioning, and make necessary adjusoneuts It would have an output of 8 .400 . drill bits annually on a twochiit, 5- day bhsis Because it would be Specially built by a machine tool manufacturer, there was no catalog. price. The cost was estimated to be $680, 000, delivered and installed. The useful life 1would be 15 years. Using a 12 year life (the remaining life of the current lathcs), the estimated salvage value would be 10% of cost . . The automatic lathe was rst introduced in 1975 at a cost of $750, 000 It was capected that as the manufacmring techniques became more generally faunliar, the price would continue to drop somewhat over the next few years- This price deciine was in stark contrast to the ination in oil services products and supplies which was 18% in _ both 1978 and 1979. A smdy prepared by the cost accountant to help decide what action to take, showed the foowing information. The direct labor rate for lathe operations was $10 per hour including fringe benefiits. Pay ratea for operators Would not change as a result of machining changes. The new machine would use less oor space, which would save $15, 000 annually on the allocated charges for square footage of space used, although the iayout of the plant was such that the freed space would be difcult to utilize and no other use was planned Miscellaneous cash expwses for supplies, maintenance and power would be $20, 000 less per year if the automatic machine were used The purchase price was subject to the 10% investment tax credit which did not reduce the depreciable cost. prurchased, thenew lathe would be nanced with a secured bankloan at 14%. Someadditionalnancial data for the company are given in Exhibit 1. This information is considered to be typical of the company '3 nancial condition, with no major changes expected in the foreseeable future EXHIBIT 1 Selected Financial Information Condensed Income Statement, 11979 ' _. Net Sales $5,364,213 ' - Cost of Geode Sold . 3,494,941 Selling General & Administrative , 64JQ Prot before Taxes ' $1,225,566 - Income Taxes m1 Net Income _ ' $622,715 Condensed Balance Sheet, 1281379 Cash '_ ' $532,122 ' Current Liabilities $930,327 . Accounts Receivable 662,107 , Long-Term Notes Outstanding (at 10%) 500,000 Inventory - - . 1.858.120 Common Stock . 1,000,000 ' . Property Assetsl . 3 '1' 1 = _ Retained Earnings . - 5.0; 1,122; _$7A42050 . 57442950 t