Big Heart Ltd has an old machine that was bought 8 years ago for $50,000. It has
ID: 2417698 • Letter: B
Question
Big Heart Ltd has an old machine that was bought 8 years ago for $50,000. It has a residual value of $2,000 at the end of its useful life of 10 years. Currently, the machine is no longer in use and has an accumulated depreciation of $38,400. The company is considering the following alternatives:1] lease out the machine to Ultra Care Ltd for $510 per month over its remaining useful life. The full maintenance cost of the machine is $600 per quarter, and Ultra Care Ltd has agreed to hear half of this cost.
2] sell the machine for an accounting profit of $500.
John, an operation manager of Big Heart Ltd, feels that it is better to lease out the machine as the accounting profit of $500 is less than the rental revenue of leading the machine.
Required:
a] do you agree with John? Explain and prepare a differential analysis report to support your answer.
b] determine the maintenance cost per year that would cause Big Heart Ltd to be indifferent about leasing or selling the machine. Big Heart Ltd has an old machine that was bought 8 years ago for $50,000. It has a residual value of $2,000 at the end of its useful life of 10 years. Currently, the machine is no longer in use and has an accumulated depreciation of $38,400. The company is considering the following alternatives:
1] lease out the machine to Ultra Care Ltd for $510 per month over its remaining useful life. The full maintenance cost of the machine is $600 per quarter, and Ultra Care Ltd has agreed to hear half of this cost.
2] sell the machine for an accounting profit of $500.
John, an operation manager of Big Heart Ltd, feels that it is better to lease out the machine as the accounting profit of $500 is less than the rental revenue of leading the machine.
Required:
a] do you agree with John? Explain and prepare a differential analysis report to support your answer.
b] determine the maintenance cost per year that would cause Big Heart Ltd to be indifferent about leasing or selling the machine.
1] lease out the machine to Ultra Care Ltd for $510 per month over its remaining useful life. The full maintenance cost of the machine is $600 per quarter, and Ultra Care Ltd has agreed to hear half of this cost.
2] sell the machine for an accounting profit of $500.
John, an operation manager of Big Heart Ltd, feels that it is better to lease out the machine as the accounting profit of $500 is less than the rental revenue of leading the machine.
Required:
a] do you agree with John? Explain and prepare a differential analysis report to support your answer.
b] determine the maintenance cost per year that would cause Big Heart Ltd to be indifferent about leasing or selling the machine.
Explanation / Answer
a)Deprecaition per year=investment-salvage/years
=50000-2000/10=$4800
At end of 8 years book value=50,000-(8*4800)=$11,600
reamining useful life = 2years=24 months
revenue=510*24=12240
cost=600*8*(1/2)=2400
depreciation=2*4800=9600
Net income=240
b) Accounting profit of $500
No, I do not agree with john as we can see second option is better than 1st option by $260.
Maintenace cost indifferent and let it be x
12240-2x-9600=500
x=$1070
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