Question

A machine purchased three years ago for $309,000 has a current book value using straight-line depreciation of $187,000; its operating expenses are $38,000 per year. A replacement machine would cost $235,000, have a useful life of nine years, and would require $8,000 per year in operating expenses. It has an expected salvage value of $64,000 after nine years. The current disposal value of the old machine is $72,000; if it is kept 9 more years, its residual value would be $18,000. Required Calculate the total costs in keeping the old machine and purchase a new machine. Should the old machine be replaced

Answer 1

Answer:

a)

Opportunity Cost (Purchase value less Salvage Value)

Old Machine = $72,000 - $18,000 = $54,000

New Machine =$235,000 - $64,000 = $171,000

Operating Costs

Old Machine = $38,000 * 9 = $342,000

New Machine = $8,000 * 9 = $72,000

Total Cost = Opportunity cost + Operating Cost

Old machine Total Cost = $54,000 + $342,000 = $396,000

New Machine Total Cost = $171,000 + $72,000 = $243,000

b)

Should the old machine be replaced? YES

The cost of keeping the old machine is more than the cost of buying and operating the new machine, therefore it is advisable to replace the old machine.

Answer 2

Answer:

the machine should be replaced

Explanation:

First, the cost of old machinery is sunk cost and no more relevant for our calculations as it would not affect our decision making at this point.

The following numbers hold value for the purpose of taking a decision as to whether the company should keep or replace the old machinery with a new one at this point and time.

 

Cost of a new machinery (if purchased)

Change in operating expenses (if machine is replaced)

Current disposal value of old machine

The company must see whether there is positive change to net income with the replacement. If there is a negative change it will not be replaced.

 

Step 2

1. Cost of new machinery= $ 235000

 

2. Changes in the operating expense/s=

Operating expense with old machine=$38000 per year for 9 years= 38000 x 9= 342000

Operating expense with new machine= $ 8000 per year for 9 years = 8000 x 9= 72000

Hence the savings in operating expenses is = $ 342000- $72000= $270000

 

3. Current Disposal value of old machine= $ 72000

Step 3

Putting together the numbers calculated in step 2-

 

Items----- --------------------------------Effect ----------------------------------Amount in $

Cost of new machine---                cash outflow                           -235000

Saving in operating expenses--- Cash inflow                          270000

Current disposal value of old machine----- Cash inflow           72000                                                                                                                                                                                                                                                                                                                                                                                                                               answer                                                                                            107000                                                                                                                                          

 

From the above calculation, it can be seen that there is a positive / net income flow of $ 107000 which is favourable to the company

 

In conclusion we can therefore, the machinery should be replaced with the new machinery.