Problem 13-30 Net Present Value; Uncertain Future Cash Flows; Postaudit [LO13-2, LO13-4]

Saxon Products, Inc., is investigating the purchase of a robot for use on the companys assembly line. Selected data relating to the robot are provided below:

Cost of the robot	$1,700,000
Installation and software	$430,000
Annual savings in labor costs	?
Annual savings in inventory carrying costs	$200,000
Monthly increase in power and maintenance costs	$2,500
Salvage value in 5 years	$82,000
Useful life	5 years

Engineering studies suggest that use of the robot will result in a savings of 20,000 direct labor-hours each year. The labor rate is $10 per hour. Also, the smoother work flow made possible by the use of automation will allow the company to reduce the amount of inventory on hand by $220,000. This inventory reduction will take place at the end of the first year of operation; the released funds will be available for use elsewhere in the company. Saxon Products has a 7% required rate of return.

Shelly Martins, the controller, has noted that all of Saxons competitors are automating their plants. She is pessimistic, however, about whether Saxons management will allow it to automate. In preparing the proposal for the robot, she stated to a colleague, Lets just hope that reduced labor and inventory costs can justify the purchase of this automated equipment. Otherwise, well never get it. You know how the president feels about equipment paying for itself out of reduced costs.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1.

Determine the annual net cost savings if the robot is purchased. (Do not include the $220,000 inventory reduction or the salvage value in this computation.)

Savings in labor costs$200,000

Savings in inventory carrying costs200,000

Total400,000

Less increased power and maintenance cost30,000

Annual net cost savings$370,000

	Now	1	2	3	4	5
Cost of the robot	$1,700,000
Installation and software	430,000
Annual net cost savings		$220,000
Inventory reduction
Salvage value (old)						82,000
Total cash flows	$2,130,000	$220,000	$0	$0	$0	$82,000
Discount factor 7%
Present value	$0	$0	$0	$0	$0	$0
Net present value	$0