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
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 2018 for $200,000. It's now January 1, 2020, and the manager of the Model Ships Division, Jeri Finley, is considering two alternatives.
Alternative 1 - Produce the complex part using the current equipment.
The following are last year's average per-unit manufacturing costs, when production was 7,800 ships:
Direct materials $3.85
Direct labor 3.70
Variable overhead 1.60
Fixed overhead 4.40
The equipment will last for five more years with zero disposal value at that time. It can be sold immediately for $20,000.
Alternative 2 - Produce the complex part with new, more efficient equipment.
The cost of the new equipment is $225,000 and will have a five-year useful life with an estimated disposal value at that time of $35,000. 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 $2.05 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. In addition, fixed overhead costs will increase by $2,500. Finley expects production to continue at 7,800 ships in each of the next five years.
Assuming a discount rate of 5%, what is the net present value if Nautical Creations buys the new equipment to produce the part?
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