Question

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of $41,000 and a remaining useful life of five years, at which time its salvage value will be zero. It has a current market value of $51,000. Variable manufacturing costs are $33,800 per year for this machine. Information on two alternative replacement machines follows.

Alternative A Alternative B
Cost $ 115,000 $ 114,000
Variable manufacturing costs per year 22,800 10,800
1. Calculate the total change in net income if Alternative A is adopted. (Cash outflows should be indicated by a minus sign.)
2. Calculate the total change in net income if Alternative B is adopted. (Cash outflows should be indicated by a minus sign.)

Answer 1

assuming a 5 year period:

1) if alternative A is adopted:

initial cash flow = $115,000 - $51,000 = -$64,000

savings per year = $33,800 - $22,800 = $11,000

$11,000 x 5 years = $55,000

net income will decrease by ($9,000)

2) if alternative B is adopted:

initial cash flow = $114,000 - $51,000 = -$63,000

savings per year = $33,800 - $10,800 = $23,000

$23,000 x 5 years = $115,000

net income will increase by $52,000