Reference no: EM133074603

Question - Nautical Creations is one of the largest producers of miniature ships in a bottle. An especially complex part of one of the ships requires special production equipment that is not useful for other products. The company purchased this equipment early in 2018 for $100,000. It's now January 1, 2020, and the manager of the Model Ships Division, Jeri Finley, is considering replacing the current equipment with new equipment that is more efficient.

The following are last year's average per-unit manufacturing costs, when production was 15,400 ships:

Direct materials $3.85

Direct labor 5.90

Variable overhead 1.65

Fixed overhead 4.35

The sales representative for the new equipment says, "The new equipment will allow direct labor to be reduced by $3.35 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 $0.27 more per unit. In addition, fixed overhead costs will increase by $2,000.

The cost of the new equipment is $205,000 and will have a five-year useful life with an estimated disposal value at that time of $15,000. The current equipment will also last for five more years. It will have zero disposal value at that time, but it can be sold immediately for $40,000.

Finley expects production to continue at 15,400 ships in each of the next five years.

Required -

1. Assuming a discount rate of 7%, what is the net present value if Nautical Creations uses their current equipment to produce the part?

2. Assuming a discount rate of 7%, what is the net present value if Nautical Creations buys the new equipment to produce the part?