Reference no: EM132514894

Mallette Manufacturing, Inc. produces professional styling blow dryers for salons. Because of increasing competition, Mallette is considering investing in an automated manufacturing system. The automated system would replace an existing system (purchased one year ago for $6 million). Although the existing system will be fully depreciated in nine years, it is expected to last another ten years. The automated system would also have a useful life of ten years.

The existing system is capable of producing 100,000 units per year. Data using the existing system are provided by the Accounting Department:

Sales per year (units)                100,000

Selling price                                 $300

Costs per unit:

Direct materials                          80

Direct labor                              90

Variable overhead                     20

Fixed overhead                         40

• All cash expenses with the exception of depreciation, which is $6 per unit. The existing equipment is being depreciated using the straight-line method with no salvage value considered.
• The automated system will cost $34 million to purchase. If the automated equipment is purchased, the old equipment can be sold for $3 million.
• The automated system will require fewer parts for production and will produce with less waste. Because of this, the direct materials cost per unit will be reduced by 25 percent. Automation will also require fewer support activities, and, as a consequence, variable overhead will be reduced by $4 per unit. Direct labor is reduced by 60 percent.
• Currently, Mallete produces and sells 80,000 units annually.

Other information:

• the automated equipment could be sold for $4 million at the end of ten years.
• the equipment of the old system would have no salvage value at the end of ten years.
• the firm's cost of capital is 12 percent.
• the automated system will require an increase in working capital of $5,000,000.
• the automated system cost of $34,000,000 will be depreciated for accounting purposes on a straight line basis over 10 years
• total annual fixed costs for the automated system will be $4,000,000 (including depreciation)

Required

Question 1: Do you recommend that Mallette purchase the automated system. Show detailed calculations.