Final answer:
In the scenario presented, Rory Company could potentially save $48,000 over 5 years by replacing its old machine with a new one, considering the reduced variable manufacturing costs and the gain on sale of the old machine.
Step-by-step explanation:
Keep or Replace Analysis in Managerial Decision Making
When a company contemplates on whether to keep or replace an asset, such as a machine, it should perform a cost benefit analysis that compares the net cash flows and operational effects of each option. In the scenario where Rory Company has to decide whether to keep its old machine or replace it with a new one, the analysis would closely examine various financial factors. The following data is considered:
Old machine's book value: $79,000
Old machine's resale value: $84,000
New machine cost: $108,000
Old machine variable costs: $36,000 per year
Cost saving with new machine: $14,400 per year
Useful life of both machines: 5 years
To conduct a keep or replace analysis, we start by calculating the total cost savings over the five-year period. This includes initial savings from selling the old machine at its current market value, which is above the book value, and the annual operating cost savings. The new machine saves $14,400 annually in variable manufacturing costs, which means $72,000 total savings over five years.
Here's how the costs break down:
Proceeds from sale of old machine: $84,000
Cost of new machine: $108,000
Net cost of new machine: $108,000 - $84,000 = $24,000
Total savings from reduced costs over 5 years: $14,400/year x 5 years = $72,000
Net savings over 5 years: $72,000 - $24,000 = $48,000
Therefore, with net savings of $48,000 over the 5-year period, it seems financially beneficial for Rory to replace the old machine with the new one. However, the company should also consider any other potential costs such as taxes, installation or adjustment costs, and financing costs before making the final decision.
By analyzing the income effects related to machine replacement, a business ensures that it is making a decision that will benefit its operations and financial health in the long term.