Answer:
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.