Best Sound, Inc. manufactures and sells high-end speakers. In 20x1, the producti
ID: 2596765 • Letter: B
Question
Best Sound, Inc. manufactures and sells high-end speakers. In 20x1, the production manager installed a new piece of production equipment. The equipment cost $5,000. It had a useful life of 5 years and zero salvage value. Estimated annual repair and maintenance costs for the production equipment is $900 and annual energy-usage costs are $3,400. The equipment can be sold today for $1,900. Recently, the company hired efficiency consultants to evaluate the company’s production processes. Among their recommendations was that the company replace the production equipment mentioned above with a newer energy efficient model. The energy efficient production equipment costs $6,000. It has an estimated useful life of 4 years and its salvage value is $1,000. Annual repairs and maintenance costs for the energy efficient model is $900 and estimated annual energy-usage costs are $1,800.
1. Prepare an analysis to determine whether the production manager should keep the one-year old production equipment or replace it with the new energy efficient model. Please show your work.
2. One concern expressed by the production manager is the effect of replacing the one year old production equipment on the current year financial income. He believes the new energy efficient model will reduce financial accounting income more than the current model. Do you agree with the production manager? Please provide analysis in support of your answer.
Explanation / Answer
1.
Analysis of Existing (Old) Equipment:
Since, the cost of machine is already incurred, it is not considered here for decision making purpose.
Total cost per annum = $900 + $3400
= $4,300
It is the equated cost per annum.
Analysis of New Equipment:
If new equipment is purchased now, then the old one will be sold for which an amount of $1900 can be received. And $6000 has to be incurred for the purchase of the new energy efficient equipment.
Annual costs = $900 + $1,800
= $2,700
Salvage value of the new equipment = $1,000
Hence, equated annual cost can be calculated as follows:
Equated Annual Cost = ((6000 - 1900) + (2700 * 4) - 1000) / 4
= (4100 + 10800 - 1000) / 4
= 13900 / 4
= $3,475.
Since, equated annual cost is more in the second case, it is better to continue with the old existing equipment and not to replace it with a energy efficient equipment.
2.
Here, only the cost details are given. It is also clearly given that the new equipment is energy efficient. It means it helps in using less energy thereby reduce cost of energy usage per annum. It has no effect on sales volume and value. So, there is no valid situation that financial accounting income would reduce because of new model. But total costs would be increased because of the new model as the equated annual cost in more. This would effect the decision making but doesn't effect the financial accounting income.
Hence, the belief of the production manager is not correct.
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