Problem
PJ systems Ltd., is using a Type 400 shaping machine to make one of its products. The company is expecting to have a large increase in demand for the product and is anxious to expand its productive capacity. The company's employees had been complaining of lack of training in the company. The employees have been complaining about the old machine and they feel that the use of the current machine is making their work inefficient as a result they are not happy. Two possibilities are under consideration:
Alternative 1. Purchase another Type 400 shaping machine to operate along with the currently owned Type 400 machine.
Alternative 2. Purchase a Type 800 shaping machine and use the currently owned Type 400 machine as standby equipment. The Type 800 machine is a high-speed unit with double the capacity of the Type 400 machine. This machine is not environmentally friendly. This machine is produced locally and will help support the community when purchased.
The following additional information is available on the two alternatives:
1) Both the Type 400 machine and the Type 800 machine have a 10-year life from the time they are first used in production. The scrap value of both machines is negligible and can be ignored. Straight-line depreciation is used.
2) The cost of a new Type 800 machine is $300,000.
3) The Type 400 machine now in use cost $160,000 three years ago. Its present book value is $112,000, and its present market value is $90,000. If the company continues using this machine, the management has decided that there will be money to support employee's training and development of about $50k a year for the next three years.
4) A new Type 400 machine costs $170,000 now. If the company decides not to buy the Type 800 machine, then the old Type 400 machine will have to be replaced in seven years at a cost of $200,000. The replacement machine will be sold at the end of the tenth year for $140,000.
5) Production over the next 10 years is expected to be:
Year Production in Units
1 40,000
2 60,000
3 80,000
4-10 90,000
6) The two Types of machines are not equally efficient. Comparative variable costs per unit are:
Type 400 800
Direct materials per unit $0.25 $0.40
Direct labor per unit 0.49 0.16
Supplies and lubricants per unit 0.06 0.04
Total variable cost per unit $0.08 $0.60
7) The Type 400 machine is less costly to maintain the Type 800 machine. Annual repairs and maintenance costs on a Type 400 machine are $2,500.
8) Repairs and maintenance costs on a Type 800 machine, with a Type 400 machine used as standby, would total $3,800 per year.
9) No other costs will change as a result of the decision between the two machines.
10) Kingsley Products has a 20% required rate of return on all investments.
Additional information:
The company has seen increased in accidents among employees while performing the job. The cost has been enormous. It is estimated it is costing the company $79,000/year. As a result the employee turnover has increased these past few years lately.
Task
(Ignore income taxes)
I. Calculate net present value for both alternatives?
II. Do incremental analysis to retain or replace the machine?