Purchase Solution

# Should the company replace the old machine with the new one? (List all relevant costs)

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This is a question from my Management Accounting class homework. It has to do with relevant costs - in this case if there needs to be a replacement of machinery. Here is the question:

Two machines:

Category Old Machine New Machine
Acquisition Cost \$300,000 \$360,000
Remaining life 4 years 4 years
Salvage Value now \$100,000 -
Salvage Value at the \$4,000 \$6,000
end of 4 years

Annual operating costs for the old machine are \$140,000. The new machine will decrease annual operating costs by \$60,000. These amounts do not include any charges for depreciation. The company used the straight-line depreciation method. These estimates of operation costs exlude rework costs. The new machine will also result in a decrease in the defect rate from the current 5% to 2.5%. All defective units are reworked at a cost of \$1.00 per unit. The company, on average, produces 100,000 units annually.

Questions:

Should the company replace the old machine with the new one? I have to list all relevant costs

What costs should be considered sunk costs for this decision?

What other factors may affect the manager's decision?

I attached the spreadsheet I have started, but I know I am setting it up wrong, I think that I am supposed to multiply everything by 100,000 since that is how many are produced annually...but I don't know where to start. Thanks!

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IF THE COMPANY GOES IN FOR THE NEW MACHINE THEN:
The decrease in costs will be: Operating costs @80,000 per year that is 320,000 for four years, salvage value 6000 -4000 = 2000, defect rate 5% - 2.5% that is 2.5% of 100,000 @ \$1 for four years = 10,000 this gives us a total decrease in cost of 332,000.

The increase in cost will be: Acquisition cost 360,000 ...

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