Woolrich Company's market research division has projected a substantial increase in demand over the next several years for one of the company's products. To meet this demand, the company will need to produce units as follows:
| Year |
Production
in Units |
| 1 |
15,000 |
| 2 |
25,000 |
| 3 |
35,000 |
| 4-10 |
40,000 |
At present, the company is using a single model 2600 machine to manufacture this product. To increase its productive capacity, the company is considering two alternatives:
Alternative 1. The company could purchase another model 2600 machine that would operate along with the one it now owns. The following information is available on this alternative:
a. The model 2600 machine now in use was purchased for $180,000 four years ago. Its present book value is $108,000, and its present market value is $104,000.
b. A new model 2600 machine costs $187,000 now. The old model 2600 machine will have to be replaced in six years at a cost of $207,000. The replacement machine will have a market value of about $170,000 when it is four years old.
c. The variable cost required to produce one unit of product using the model 2600 machine is given under the "general information" below.
d. Repairs and maintenance costs each year on a single model 2600 machine total $5,000.
Alternative 2. The company could purchase a model 5200 machine and use the old model 2600 machine as standby equipment. The model 5200 machine is a high-speed unit with double the capacity of the model 2600 machine. The following information is available on this alternative:
a. The cost of a new model 5200 machine is $257,000.
b. The variable cost required to produce one unit of product using the model 5200 machine is given under the "general information" below.
c. The model 5200 machine is more costly to maintain than the model 2600 machine. Repairs and maintenance on a model 5200 machine and on a model 2600 machine used as a standby would total $5,300 per year.
The following general information is available on the two alternatives:
a. Both the model 2600 machine and the model 5200 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 by the company.
b. The two machine models are not equally efficient. Comparative variable costs per unit of product are as follows:
Model
2600 |
Model
5200 |
| Direct materials per unit |
$ |
0.52 |
$ |
0.30 |
| Direct labor per unit |
|
0.40 |
|
0.44 |
| Supplies and lubricants per unit |
|
0.08 |
|
0.06 |
| |
| Total variable cost per unit |
$ |
1.00 |
$ |
0.80 |
c. No other factory costs would change as a result of the decision between the two machines.
d. Woolrich Company uses an 24% discount rate. (Ignore income taxes.)
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
Required:
1a. What is the net present value of alternative 1? (Use the total cost approach.) (Negative amount should be indicated by a minus sign. Round discount factor(s) to 3 decimal places, other intermediate calculations and final answer to the nearest whole dollar.)
1b. What is the net present value of alternative 2? (Use the total cost approach.) (Negative amount should be indicated by a minus sign. Round discount factor(s) to 3 decimal places, other intermediate calculations and final answer to the nearest whole dollar.)
1c. Which alternative should the company choose?
2. Suppose that the cost of direct materials increases by 50%. Would this make the model 5200 machine more or less desirable?
3. Suppose that the cost of direct labor increases by 25%. Would this make the model 5200 machine more or less desirable?