Question

Lexigraphic Printing Company is considering replacing a machine that has been used in its factory for four 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, 10-year life $89,000
Annual depreciation (straight-line) 8,900
Annual manufacturing costs, excluding depreciation 23,600
Annual non-manufacturing operating expenses 6,100
Annual revenue 74,200
Current estimated selling price of machine 29,700
New Machine
Purchase price of machine, six-year life $119,700
Annual depreciation (straight-line) 19,950
Estimated annual manufacturing costs,
excluding depreciation 6,900
Annual non-manufacturing operating expenses and revenue are not expected to be affected by purchase of the new machine.
Required:
1. Prepare a differential analysis as of April 30 comparing operations using the present machine (Alternative 1) with operations using the new machine (Alternative 2). The analysis should indicate the total differential income that would result over the six-year period if the new machine is acquired. Refer to the lists of Labels and Amount Descriptions for the exact wording of the answer choices for text entries. For those boxes in which you must enter subtracted or negative numbers use a minus sign. If there is no amount or an amount is zero, enter "0". A colon (:) will automatically appear if required.
Differential Analysis
Continue with Old Machine (Alternative 1) or Replace Old Machine (Alternative 2)
April 30
1 Continue with Old Machine Replace Old Machine Differential Effect on Income
2 (Alternative 1) (Alternative 2) (Alternative 2)
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5
6
7
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2. Choices of what other factors should be considered.
Was the purchase price of the old machine too high?
What effect does the federal income tax have on the decision?
What opportunities are available for the use of the $90,000 of funds ($119,700 less $29,700 proceeds from the old machine) that are required to purchase the new machine?
Should management have purchased a different model of the old machine?
Are there any improvements in the quality of work turned out by the new machine?

Answer 1

old machine:

depreciation costs $8,900

other manufacturing costs $23,600

other non-manufacturing expenses $6,100

annual revenue $74,000

new machine:

purchase price $119,700 - 29,700 (sales price of old machine) = $90,000

depreciation costs $19,950

other manufacturing costs $6,900

other non-manufacturing expenses $6,100

annual revenue $74,000

1)

DIFFERENTIAL ANALYSIS

Alternative 1 Alternative 2 Differential

old machine new machine amount

Purchase cost $0 ($119,700) ($119,700)

Proceeds from sale $0 $29,700 $29,700

Total revenues $444,000 $444,000 $0

Manufacturing costs ($141,600) ($41,400) $100,200

(excluding dep.)

Other non- ($36,600) ($36,600) $0

manufacturing costs

Total $265,800 $276,000 $10,200

If the company purchases the new machine, its differential revenue will be higher considering the 6 years of useful life. But we are missing two important aspects: required rate of return and tax rate, which could affect our decision.

2) Choices of what other factors should be considered.

What effect does the federal income tax have on the decision?

• Net cash flows are affected by deprecation expense and how they are taxed. Alternative 2 would benefit from higher tax rates.

What opportunities are available for the use of the $90,000 of funds ($119,700 less $29,700 proceeds from the old machine) that are required to purchase the new machine?

• We should discount the future cash flows using the company's WACC.

Are there any improvements in the quality of work turned out by the new machine?

• If the new machine improves the quality of our products or reduces production time, then that is something that should be considered.