Precision Parts II: EAC problem

Individual submission (team submission not allowed)

Please submit excel file by 11:59 PM on 4/12

Precision Parts makes parts and equipment for the oil and gas industry such as drill bits, drilling pipe, and tubing. As such, the firm requires specialized equipment for oil drilling. One profitable product for the firm is diamond-impregnated drill bits. Using an innovative and proprietary design, the firm crafts durable dill bits suitable both for hard and soft rock formation and having a long use-life. Although expensive, these high-tech drill bits offer significant savings to drillers because they minimize disruptions to the production process caused by faulty bits that needs repairing in a time-consuming process which involves taking the pipe out of the ground to make necessary repairs. The firm expects to sell 2,500 drill bits a year, each at a price of about $100,000.

The production of drill bits needs highly specialized tooling equipment. The firm solicits bids from two different vendors for one particular tool required in the production process. An Italian vendor offers the more economical model costing $1 million while a U.S. firm offers a more sophisticated model costing $2 million. Both models largely offer the same usage for Precision Parts, although the US model would provide labor and material savings of $75 per drill bit. Also, the projected economic life of the US model is longer by 4 years, at 12 years. Both machines are expected to have salvage values (market value at the end of economic life) of about 25% of cost.

Within the production team in Precision Parts, the discussion over this choice is intense. The engineers in the team advocate the U.S. model while the business-oriented team members advocate the Italian model. The team solicits help from an RIT student Li Na currently interning with the firm to resolve the problem.

Li sets about collecting financial information from the firm's financial headquarters. The firm faces a tax rate of 34% and a capital cost of 8%. Furthermore, the accounting group indicates that the both pieces of equipment would be depreciated to zero over a hypothetical 10 year life.

Li also consults with the engineers in the group to obtain estimates of maintenance costs and finds that annual maintenance expenses for the US model are three times higher, at $45,000.

Li is wondering about the appropriate financial method for selecting between the two alternatives. The objective would be to explain the method and to execute the calculations in order to show details clearly to the production team.

All things considered, which machine the firms should chose to buy?

What is the break-even price of the U.S. machine?

What is the break-even number of drill bits a year the firm has to sell?

What are the non-quantifiable factors that the company should consider?