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https://stream.massey.ac.nz/mod/book/view.php?id=5430644&chapterid=1354036.

Australia. For more than a decade, OPL has relied on a conventional injection-moulding production line to manufacture its standard container products. Increasing competition from overseas suppliers has recently placed pressure on the company’s margins and prompted management to consider upgrading its production technology.

Over the past year, OPL’s engineering department evaluated several automation technologies available in the market. In the process, the company spent $95,000 on technical assessments, consultant fees, and prototype testing related to the automated system currently under consideration. The operations manager has proposed replacing the existing production line with a new automated injection-moulding system that is expected to improve production efficiency and reduce operating costs.

During the most recent financial year, OPL produced and sold 500,000 containers at an average price of $8 per unit. Sales volume for this product line has historically grown at approximately 2% per year, and management expects this growth rate to continue if the current production system remains in place.

The variable production cost is currently $4.80 per unit, which includes raw materials, labour, and energy consumption. Annual fixed operating costs associated with the existing production line amount to $250,000, and both variable and fixed costs are expected to increase at 2% annually.

OPL purchased the current production line five years ago for $3.5 million. The equipment was originally expected to have a 10-year useful life. The production line could be sold today for $2.5 million, although if it continues to be used for the remaining five years, its resale value is expected to decline to approximately $200,000.

The proposed automated moulding system would cost $4.8 million, with an additional $200,000 required for shipping, installation, and calibration. Consistent with OPL’s financing policy, 40% of the purchase cost of the new automated system will be financed through a bank loan carrying an interest rate of 9%. The equipment supplier indicates that the automated system would reduce material waste and labour requirements, lowering expected variable costs to $4.40 per unit. Annual fixed operating costs associated with the automated system are estimated to be $220,000. The estimation of 2% growth rate in both costs remains.

The improved manufacturing precision is also expected to enhance product quality. OPL’s marketing department believes that the improved product quality could allow the company to charge a selling price of $8.40 per unit next year, and sales volume is expected to grow 4% annually over the next five years (that is, 520,000 units next year) if the new technology is adopted. The automated production line has an economic life of five years. Due to strong demand for this latest technology equipment, it is expected to have a salvage value of $5.1 million at the end of its economic life.

OPL currently produces a premium airtight container series that is manufactured on a separate production line. Currently, this premium product sells for $11 per unit and has a variable cost of $6.50 per unit. Management estimates that if the automated system is introduced, the improved quality of the standard container may attract some customers who currently purchase the premium series. As a result, sales of the premium container series are expected to decline by approximately 30,000 units every year. Fixed costs associated with the premium product line would remain unchanged. OPL typically maintains net working capital equal to 15% of next year’s sales revenue, and it will be fully recovered at the end of the project’s life. Nevertheless, working capital associated with the premium container series is managed at the corporate level and is assumed to remain unchanged for the purpose of this analysis.

Both the existing production line and the proposed automated system qualify as “moulding machines (injection)” under Inland Revenue’s depreciation schedule. However, the existing machine is currently being depreciated using the straight-line method at 8.5%, while the new automated system will be depreciated using the diminishing value method at a rate of 13% per year.

OPL’s corporate tax rate is 28%. The company’s weighted average cost of capital (WACC) is estimated to be 15%, which management uses as the required rate of return when evaluating replacement projects. The expected inflation rate, which will affect all selling prices per unit, is approximated 2.5% per year.