A company currently sells 850,000 units per year of a product to one customer at a price
Question:
A company currently sells 850,000 units per year of a product to one customer at a price of $0.80 per unit. The customer requires that the product be exclusive and expects no increase in sales during the next year. The product is manufactured with a machine that was purchased seven years ago at a cost of $500,000. Currently, the machine has a book value of $150,000 but its market value is only $30,000. The machine is expected to last another three years, after which it will have no salvage value. The annual activity is 200,000 machine hours and each product requires 0.20 machine hours. Fixed overhead includes depreciation. Last year, the production costs per unit were as follows:
Direct materials..............................$0.20
Direct labour...................................0.12
Variable overhead.............................0.08
Fixed overhead................................0.15
Total cost per unit...........................$0.55
The company president is considering replacing the old machine with a new one that would cost $400,000. The new machine is expected to last five years. At the end of that period, the salvage value will be $50,000. The president expects to save 10% of the company's total variable costs with the new machine.
Instructions
Assume that the company's desired rate of return is 12%. Using the net present value method, determine if the company should replace the old machine with the new one, and briefly explain why or why not. Show your calculations.
Net Present ValueWhat is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...
Step by Step Answer:
Managerial Accounting Tools for Business Decision Making
ISBN: 978-1118856994
4th Canadian edition
Authors: Jerry J. Weygandt, Paul D. Kimmel, Donald E. Kieso, Ibrahim M. Aly