The XYZ Corporation is contemplating the introduction of a new machine tool which will be used solely in the manufacture of a rotor shaft. 50,000 units per year are expected to be manufactured, and the time study group anticpates a standard of 2.5 hours per piece. The labor rate for the first year is expected to be 5.60 per hour. The present method takes 3.0 hours at the same rate. The new machine tool will cost $800,000 and will be depreciated on a straight line basis over a period of 10 years with no residual value. $150,000 of special tools will be needed. It is expected that the useful life of the special tools will be 250,000 pieces. The benefit rate is 30 percent.
Basing your judgment solely on the facts listed above, should the tool be purchased?
To determine whether the new machine tool should be purchased, we need to compare the costs and benefits associated with its implementation. Let's break down the information provided:
1. Cost of the new machine tool:
- Machine cost: $800,000
- Special tools cost: $150,000
2. Expected production:
- 50,000 units per year
3. Time study group standards:
- New machine tool: 2.5 hours per piece
- Present method: 3.0 hours per piece
4. Labor rate for the first year:
- $5.60 per hour
5. Useful life of special tools:
- 250,000 pieces
6. Benefit rate:
- 30 percent
Now, let's calculate the relevant costs and benefits:
1. Total cost of the new machine tool:
- Machine cost: $800,000
- Special tools cost: $150,000
- Total: $950,000
2. Total labor cost using the new machine tool (per year):
- Time per piece: 2.5 hours
- Labor rate: $5.60 per hour
- Total labor cost per piece: 2.5 hours * $5.60 per hour = $14 per piece
- Total labor cost per year: $14 per piece * 50,000 units = $700,000
3. Total labor cost using the present method (per year):
- Time per piece: 3.0 hours
- Labor rate: $5.60 per hour
- Total labor cost per piece: 3.0 hours * $5.60 per hour = $16.80 per piece
- Total labor cost per year: $16.80 per piece * 50,000 units = $840,000
4. Total cost savings (per year):
- Cost savings per year: $840,000 - $700,000 = $140,000
5. Depreciation expense (per year):
- Machine cost: $800,000
- Useful life: 10 years
- Depreciation expense per year: $800,000 / 10 years = $80,000 per year
6. Benefit (per year):
- Benefit rate: 30 percent
- Total benefit per year: $140,000 * 30% = $42,000 per year
Now, let's assess whether the tool should be purchased:
The net cost (total cost - total benefit) for the first year would be:
- ($950,000 - $42,000) = $908,000.
If the net savings (cost savings - depreciation expense) in subsequent years are greater than the net cost for the first year, then the tool should be purchased.
Please note that this analysis does not consider other potential costs, such as maintenance, repairs, or changes in production demand. It is also important to perform a comprehensive cost-benefit analysis to thoroughly evaluate the purchase decision.