Reference no: EM132734772

Question - Boat Crafts 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, John Smith, 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 8,200 ships:

Direct Material $3.85

Direct Labor 3.50

Variable Overhead 1.65

Fixed Overhead 4.50

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 $210,000 and will have a five-year useful life with an estimated disposal value at that time of $50,000. 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 $2.20 per unit." Smith thinks this estimate is accurate, but also knows that a higher quality of direct material will be necessary with the new equipment, costing $0.19 more per unit. In addition, fixed overhead costs will increase by $2,000.

Smith expects production to continue at 8,200 ships in each of the next five years.

Assuming a discount rate of 7%, what is the net present value if Boat Crafts uses their current equipment to produce the part?

Assuming a discount rate of 7%, what is the net present value if Boat Crafts buys the new equipment to produce the part?