Differential analysis for machine replacement Kim Kwon Digital Components Compan

Question

Differential analysis for machine replacement Kim Kwon Digital Components Company assembles circuit boards by using a manually operated machine to insert electronic components. The original cost of the machine is $60,000, the accumulated depreciation is $24,000, its remaining useful life is five years, and its residual value is negligible. On May 4 of the current year, a proposal was made to replace the present manufacturing procedure with a fully automatic machine that has a purchase price of $180,000. The automatic machine has an estimated useful life of five years and so significant residual value. For use in evaluating the proposal, the accountant accumulated the following annual data on present and proposed operations: Prepare a differential analysis dated May 4 to determine whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2). Prepare the analysis over the useful life of the new machine. Based only on the data presented, should the proposal be accepted? What are some of the other factors that should be considered before a final decision is made?

Explanation / Answer

(a)

(b) Cost savings = 35500x5 =177500

Initial investment in new machine = 180000

Loss = 2500

It is not feasible to replace existing machine

(c) Companies discount rate, Tax savings on depreciation are some of the factors that should be considered before final decision is made.

Particulars Aternative 1 Alternative 2 Initial expenditure 0 180000 Sales 205000 205000 Direct Material 72000 72000 Direct labour 51000 0 Power and maintenance 5000 12000 Taxes, Insurance,etc. 1500 4000 Selling and administrative expenses 45000 45000 Total Expenses 174500 139000

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