Reference no: EM131293648
Kitch Company manufactures three different models of paper shredders including the waste container that serves as the base. While the shredder heads are different for the three models, the waste container is the same. The number of waste containers that Kitch will need during the next five years is estimated as follows:
20X1 50,000
20X2 50,000
20X3 52,000
20X4 55,000
20X5 55,000
The equipment used to manufacture the waste container must be replaced because it is broken and cannot be repaired. Management is considering the purchase of robotic equipment to replace the old machinery. The new equipment would have a purchase price of $945,000. There will be a 2 percent discount if payment is made within 10 days. Company policy is to take all purc hase discounts. The freight costs on the equipment would be $11,000, and installation costs would total $22,900. Freight and installation costs will be included in the equipment’s costs basis for depreciation purposes, the company uses straight-line depreciation with a half year convention. The equipment would be purchased in December of the current year and placed into service on January 1, 20X1. It would have a five-year useful life. The equipment is expected to have a salvage value of $12,000 at the end of its useful life in 20X5. The new equipment will result in a 50 percent reduction in direct labor and a 25 percent reduction in variable overhead. There will be an additional one-time permanent decrease in working capital requirements of $2,500, resulting from a reduction in direct-material inventories. This working capital reduction would be recognized in the analysis at the time of the equipment acquisition.The old equipment has a book value of $5,000, and it can be sold for a salvage value of $1,500. The current per unit manufacturing costs related to the production of the container follow:
Direct material $ 8.00
Direct labor 10.00
Variable overhead 6.00
Fixed overhead:
Supervision $ 2.00
Facilities 5.00
General 4.00 11.00
Total manufacturing costs per unit $35.00
Kitch does not anticipate any changes in the fixed manufacturing costs if the new equipment is purchased. The company is subject to a 40 percent income tax rate. Management assumes that all annual cash flows and tax payments occur at the end of the year and uses a 12 percent discount rate.
REQUIRED:
1. What is the NPV of purchasing the new equipment?
2. What is the payback period for the new equipment? Round your answer two points past the decimal.
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