PR 24-2B Differential analysis for machine replacement proposal OBJ. Flint Tooli

Question

PR 24-2B Differential analysis for machine replacement proposal OBJ. Flint Tooling Company is considering replacing a machine that has been used in its factory for two years. Relevant data associated with the operations of the old machine and the new machine, neither of which has any estimated residual value are as follows: Old Machine Cost of machine, eight-year life Annual depreciation (straight-line) Annual manufacturing costs, excluding depreciation Annual nonmanufacturing operating expenses Annual revenue Current estimated selling price of the machine $38,000 4,750 12,400 2,700 32,400 12,900

Explanation / Answer

The life of old machine = 38000/4750 = 8 years

Remaining life = 8-2 = 6 years

So,

Differential cash flows:

Year 0: 12900-57000 = -44100

Year 1 to 6: Change in annual depreciation + annual manufacturing costs

= (9500-4750)+(12400-3400) = 13750

So, net benefit of replacing old machine

= -44100 + 6*13750

= 38400

Since, net income from replacement is positive, the machine should be replaced.

2. Before making the decision, the other things like coat of capital, quality of machine, quality of products produced, ease of use etc. should also be considered.

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