Armstrong Company manufactures three models of paper shredders, including the waste container, which serves as the base. Whereas the shredder heads are different for all three models, the waste container is the same. The number of waste containers that Armstrong will need during the next five years is estimated as follows:
Year Number of Containers
2008 .......... 50,000
2009 .......... 50,000
2010 .......... 52,000
2011 .......... 55,000
2012 .......... 55,000
The equipment used to manufacture the waste container must be replaced because it is broken and cannot be repaired. The new equipment has a purchase price of $945,000 and is expected to have a salvage value of $12,000 at the end of its economic life in 2012. The new equipment would be more efficient than the old equipment, resulting in a 25 percent reduction in direct materials and a onetime decrease in working capital requirements of $2,500 resulting from a reduction in direct materials inventories. This working capital reduction would be recognized at the time of equipment acquisition.
The old equipment is fully depreciated and is not included in the fixed overhead. The old equipment can be sold for a salvage amount of $1,500. Armstrong has no alternative use for the manufacturing space at this time, so if the waste containers were purchased from an outside supplier, the old equipment would be left in place. Rather than replace the equipment, one of Armstrong’s production managers has suggested that the waste containers be purchased. One supplier has quoted a price of $27 per container. This price is $8 less than the current manufacturing cost, which is comprised of the following:
Armstrong employs a plantwide fixed overhead rate in its operations. If the waste containers were purchased outside, the salary and benefits of one supervisor, included in the fixed overhead at $45,000, would be eliminated. There would be no other changes in the other cash and noncash items included in fixed overhead.

Armstrong 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 after-tax discount rate.

A. Define the problem that Armstrong faces.
B. Calculate the net present value of the estimated after-tax cash flows for each option you identify.
C. What is your recommendation? Support your recommendation by explaining the logic behindit.

  • CreatedMarch 11, 2015
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