Question

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of $43,000 and a remaining useful life of 4 years, at which time its salvage value will be zero. It has a current market value of $53,000. Variable manufacturing costs are $33,500 per year for this machine. Information on two alternative replacement machines follows. Alternative A Alternative B Cost $ 119,000 $ 117,000 Variable manufacturing costs per year 22,300 11,000 Calculate the total change in net income if Alternative A, B is adopted. Should Xinhong keep or replace its manufacturing machine

Answer 1

Answer:

Option A  financial disadventage of 21,200

Option B financial advantage of 26,000

The company should go for alternative B

Explanation:

                                       old              A    Differential

Purchase                            -119000 -119,000

Proceeds from sale             53,000       53,000

Variable cost           -134,000    -89,200   44,800

Total                    -134000   -155200 -21,200

                                old               B     Differential

Purchase                               -117000 -117,000

Proceeds from sale               53,000     53,000

Variable cost                -134,000      -44,000   90,000

Total                         -134000     -108000 26,000

Notes:

• The book value is irrelevant for this question.
• When going for either alternative we are selling the old machine at their fair value. So we have proceeds from the sale
• Then the variable cost of the old and each alternative are multiply by 4 becuase, that is the useful life of the machines in year.
• We add them all and check the difference

Alternative A has a negative differential income, so it is not viable

Alternative B has a positive differential income, it is viable.