AMT plc is increasing the level of automation of a production line
dedicated to a single product. The options available are total
automation or partial automation. The company works on a planning
horizon of five years and either option will produce the 10,000 units
which can be sold annually. Total automation will involve a total
capital cost of £1 million. Material costs will be £12 per unit and
labour and variable overheads will be £18 per unit with this method.
Partial automation will result in higher material wastage and an average
cost of £14 per unit. Labour and variable overhead are expected to cost
£41 per unit. The capital cost of this alternative is £250,000. The
products sell for £75 each, whichever method of production is adopted.
The scrap value of the automated production line, in five years’ time,
will be £100,000, while the line which is partially automated will be
worthless. The management uses straight-line depreciation and the
required rate of return on capital investment is 16 per cent p.a.
Depreciation is considered to be the only incremental fixed cost. In
analysing investment opportunities of this type the company calculates
the average total cost per unit, annual net profit, the break-even
volume per year and the discounted net present value.
(a) Determine the figures which would be circulated to the management of AMT plc in order to assist their investment analysis.
(b) Comment on the figures produced and make a recommendation with any qualifications you think appropriate.