single part, a gear, requires specialized tools which now need to
be replaced. Management has decided that the only alternative to
replacing these tools is to acquire the gear from an external
source. GearCo. is willing to supply the gear at a price of $39 per
unit. Historically AMI uses an average of 105,000 gears per year
and usage is expected to remain at this level over the next five
years. Unit manufacturing costs for 2020 were as follows:
Direct materials$17
Direct labour $12
Variable overhead $8
Fixed overhead1 $4
Total unit cost $41
1Fixed overhead is all cash expenses with the
exception of amortization, which is $1 per unit.
The existing equipment is being amortized on a straight-line
basis with no salvage value considered.
The balance is for other fixed overhead costs that will not
change regardless of whether the new specialized tools are
purchased or Probe provides the gears.
If the specialized tools are purchased, they will cost
$1,100,000 and will have a salvage value of $100,000 after their
expected economic life of 5 years. Straight-line amortization is
used for accounting purposes. The specialized tools' capital cost
allowance (CCA) rate is 20%. Variable conversion costs will be
reduced by $3 per unit according to the manufacturer. An increase
of $2 per unit in raw material cost is expected because a higher
quality of materials has to be used with the new tools. The company
requires a 11% after-tax return on investment, and it has a 28% tax
rate.
Use the net present value method to conduct a differential
(incremental analysis) to determine whether AMI should replace the
old tools or purchase the gear from GearCo. Should AMI
purchase the tools? and if there is a net cash savings what
will it be?
- Ami Produces Several Lines Of Machine Products Currently A Single Part A Gear Requires Specialized Tools Which Now 1 (156.1 KiB) Viewed 43 times