Question

Ivanhoe Company has a factory machine with a book value of $88,100 and a remaining useful life of 7 years. It can be sold for $33,800. A new machine is available at a cost of $510,700. This machine will have a 7-year useful life with no salvage value. The new machine will lower annual variable manufacturing costs from $576,600 to $470,500. Prepare an analysis showing whether the old machine should be retained or replaced. (In the first two columns, enter costs and expenses as positive amounts, and any amounts received as negative amounts. In the third column, enter net income increases as positive amounts and decreases as negative amounts. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Answer 1

Total costs are reduced with the new machine.

Step-by-step explanation:

scenario 1: keep using old machine

machine cost = $88,100

variable expenses = $576,600 x 7 = $4,036,200

total expenses for 7 years = $4,124,300

scenario 2: purchase new machine

machine cost = $510,700 - $33,800 = $476,900

variable expenses = $470,500 x 7 = $3,293,500

total expenses for 7 years = $3,770,400

difference in total expenses = $3,770,400 - $4,124,300 = $353,900 favorable for new machine

Since the total costs are lower when you purchase the new machine, then you should go ahead and do it. Generally when you carry on a project that needs a significant investment like this new machine, you should use an interest rate to calculate present value, but you could also lease the machine instead of purchasing it (since it has no residual value).