Question

Mountain Gear has been using the same machines to make its name brand clothing for the last five years. A cost efficiency consultant has suggested that production costs may be reduced by purchasing more technologically advanced machinery. The old machines cost the company $360,000. The old machines presently have a book value of $136,000 and a market value of $28,000. They are expected to have a five-year remaining life and zero salvage value. The new machines would cost the company $260,000 and have operating expenses of $19,000 a year. The new machines are expected to have a five-year useful life and no salvage value. The operating expenses associated with the old machines are $46,000 a year. The new machines are expected to increase quality, justifying a price increase, and thereby increasing sales revenue by $26,000 a year. Select the true statement.
A. The company will be $44,000 better off over the 5-year period if it replaces the old equipment.

B. The company will be $72,000 better off over the 5-year period if it keeps the old equipment.

C. The company will be $33,000 better off over the 5-year period if it replaces the old equipment.

D. The company will be $28,000 better off over the 5-year period if it replaces the old equipment.

Answer 1

Answer:

C. The company will be $33,000 better off over the 5-year period if it replaces the old equipment.

Explanation:

keep old machine:

operating expenses = $46,000 x 5 = $230,000

new machine:

purchase cost $260,000 - $28,000 = $232,000

operating expenses = $19,000 x 5 = $95,000

increase in revenue $26,000 x 5 = $130,000

if new machine is purchased, operating costs decrease by $135,000, revenues increase by $130,000, but investment outflows increase by $232,000 ⇒ $135,000 + $130,000 - $232,000 = $33,000