Ms. Sara Ritter is the distribution manager for the Fiesta Soft Drink Company. She is considering full automation of the plant’s warehouse. At present, the warehouse utilizes a mechanized system of materials handling. The current system employs 20 laborers at an average wage rate of $13/hour. Laborers work an average of 2,000 hours per year. The mechanization costs $18,000 annually to maintain. The equipment was purchased two years ago with uniform payments of $25,000 made annually. In year 9, the mechanical equipment will be replaced by new machinery with fixed annual costs of $35,000. In addition, it will cost Fiesta $12,000 per year to maintain the new equipment with the same 20 laborers.
The automated equipment would cost $1.2 million upfront for implementation. Only eight laborers and an automation specialist would be required to maintain operations in the new system. The laborers would earn $16/hour over 2,000 hours each year. The automation specialist would earn a salary of $56,000 per year, increasing 2 percent annually after the first year. Much of the old mechanized equipment could be sold immediately for a total of $125,000. Maintenance of the automated system is estimated at $60,000 each year with this cost growing by 3 percent annually after the first year. The automated system is expected to serve Fiesta for 15 years.
a. Examine the cash flow under each system. What is the payback period for automation?
b. What advantages aside from long-term cost savings might an automated warehouse have over more labor-intensive systems?