old device:
depreciation costs $8,900
other manufacturing costs $23,600
other non-manufacturing expenses $6,100
annual income $74,000
new device:
purchase price $119,700 - 29,700 (sale price of old machine) = $90,000
amortization costs $19,950
other manufacturing costs $6,900
other non-manufacturing expenses $6,100
annual income $74,000
1)
DIFFERENTIAL ANALYSIS
Alternative 1 Alternative 2 Differential
old machine new machine quantity
Purchase cost $0 ($119,700) ($119,700)
Sale proceeds $0 $29,700 $29,700
Total revenue $444,000 $444,000 $0
Manufacturing costs ($141,600) ($41,400) $100,200
(outside department)
Other no ($36,600) ($36,600) $0
manufacturing costs
Total $265,800 $276,000 $10,200
If the company buys the new machine, its incremental income will be higher considering the 6 years of useful life. But we are missing two important things: the required rate of return and the tax rate, which could influence our decision.
2) Choice of other factors to be taken into account.
What effect does federal income tax have on the decision?
Free cash flow is affected by depreciation expense and how it is taxed. Alternative 2 would benefit from higher tax rates.
What opportunities are available for the use of the $90,000 funds ($119,700 minus $29,700 profit from the old machine) needed to purchase the new machine?
We should discount future cash flows using the company's WACC.
Is there an improvement in the quality of work produced by the new machine?
Whether the new machine improves the quality of our products or reduces production time is something to consider.
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