The Techsphere Toy Company was one of the original producers of "Thing-a-magig. An especially complex part of Thing-a-magig needs special tools that are not useful for other products. These tools were purchased on November 16, 2017 for $200,000.

It is now August 1, 2020. The manager of the Thing-a-magig Division, Antonia, is contemplating three alternatives:

First, the company could continue to produce "Thing-a-magig" using the current tools; they will last another five years, at which time they would have zero terminal value.

Second, the company could sell the tools for $30,000 and purchase the parts from an outside supplier for $1.10 each.

Third, the company could replace the current tools with new, more efficient tools costing $180,000. Antonia expects to produce 80,000 units of Thing-a-magig in each of the next five years.

Manufacturing costs for the part have been as follows, and no change, in costs is expected:

Direct material $0.38

Direct labour 0.37

Variable overhead 0.17

Fixed overhead 0.45*

Total unit cost $1.37

* Amortization accounts for two-thirds of the fixed overhead. The balance is for other fixed overhead costs of the factory that require cash outlays, 60 percent of which would be saved if production of the parts were eliminated.

The outside supplier offered the $1.10 price as a once-only offer. It is unlikely such a low price would be available later. Techsphere Toy would also have to guarantee to purchase at least 70,000 parts for each of the next five years.

The new tools that are available would last for five years with a disposal value of $40,000 at the end of five years. Tools qualify for CCA at 30 percent declining balance for tax purposes. Straight-line amortization is used for book purposes. The sales representative selling the new tools stated, The new tools will allow direct labour and variable overhead to be reduced by $0.21 per unit. Antonia thinks this estimate is accurate. However, she also knows that a higher quality of materials would be necessary with the new tools.

She predicts the following costs with the new tools:

Direct material $0.40

Direct labour 0.25

Variable overhead 0.08

Fixed overhead 0.60**

Total unit cost $1.33

**The increase in fixed overhead is caused by amortization on the new tools.

The company has a 40 percent marginal tax rate and requires a 12 percent after-tax rate of return.

Required:

1. Which alternative should Antonia select and recommend? Apply the net present value method for your quantitative determinations to support your decision while recognizing all applicable tax implications.

2. What are some factors besides the net present value that should influence Antonia's

selection?