Adams Products, Inc., manufactures a product it sells for $25. Adams sells all o

Question

Adams Products, Inc., manufactures a product it sells for $25. Adams sells all of the 24,000 units per year it is capable of producing at the current time, and a marketing study indicates that it could sell 14,000 more units per year. To increase its capacity, Adams must buy a machine that has the capacity to produce 50,000 units of its product annually. The existing equipment can produce the product at a unit cost of $16. Today it has a book value of $80,000 and a market value of $60,000. The new equipment could produce 50,000 units at a unit cost of $12. The new equipment would cost $500,000 and would be depreciated uniformly over its five-year life. If the new machine is purchased, fixed operating costs will decrease by $20,000 per year. If Adams's cost of capital is 18 percent and its tax rate is 30 percent, should Adams buy the new machine? Why?

Explanation / Answer

Adam should buy the new machine . Because the fixed operating costs are excluded in the new machine purchases. The total output units are also increased, while using the new machine.

Old machine24,000 units New Machine 50,000units Difference Details Per unit Total Per unit Total Sales $25 $600,000 $25 1,250,000 650,000 Cost of production 16 384,000 12 600,000 216,000 Fixed operatiing cost $20,000 0 equipment cost $60,000 $500,000 Cost of capital 18% 0 90,000 Total cost 464,000 1,190,000 Profit 136,000 60,000 76,000 Tax 30% 40,800 18,000 Profit after tax 95,200 42,000 53,200

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