Problem:
Atlanta Industrial has been approached by one of its customers about producing 400,000 special-purpose parts for a new farm implement product. The parts would be required at a rate of 50,000 per year for eight years. T provide these parts, Atlanta Industrial would need to acquire several new production machines. These machines would cost $500,000 in total. The customer has offered to pay Atlanta Industrial $50 per unit for the parts. Managers at Atlanta Industrial have estimated that, in addition to the new machines, the company would incur the following costs to produce each part:
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Direct labor
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$ 8
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Direct material
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10
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Variable overhead
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4
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Total
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$22
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In addition, annual fixed out-of-pocket costs would be $40,000. The new machinery would have no salvage value at the end of its eight-year life. The company uses a discount rate of 8 percent to evaluate capital projects.
a. Compute the net present value of the machine investment (ignore tax).
b. Based on the NPV computed in part (a), is the machine a worthwhile investment? Explain.
c. Aside from the NPV, what other factors should Atlanta Industrial's managers consider when making the investment decision?