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Relevant Costs and Differential Analysis: Check Sorting Machine

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Coastal Community Bank paid $50,000 for a check sorting machine in January 2005. The machine had an estimated life of 10 years and annual operating costs of $40,000, excluding depreciation. Although management is pleased with the machine, recent technological advances have made it obsolete. Consequently, as of January 2009, the machine has a book value of $30,000, a remaining operating life of 6 years, and a salvage value of $0.
The manager of operations is evaluating a proposal to acquire a new optical scanning and sorting machine. The new machine would cost $90,000 and reduced annual operating costs to $20,000, excluding depreciation. Because of expected technological improvements, the manager believe the new machine will have an economic life of 6 years and no salvage value at the end of that life. Prior to signing the papers authorizing the acquisition of the new machine, the president of the Coastal Community Bank prepared the following analysis;

Six year savings [($40,000 - $20,000) x 6 years] $120,000
Cost of new machine (90,000)
Lost on disposal of old machine (30,000)
Advantage (disadvantage) of replacement $ 0

After looking at these numbers, he rejected the proposal and commented that he was â??tired of looking at marginal projects. This bank is in business to make a profit, not to break even. If you want to break even go and work for the government.

Required
a. Evaluate the president's analysis.
b. Prepare a differential analysis of six-year totals for the old and the new machines.
c. Speculate on some limitations of the model or other issues that might be a factor in making a final
decision.

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Solution Summary

Relevant costs and differential analysis checking sorting machines are examined.

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P16-30-a
"The president's analysis considers two factors viz the differential cost savings between the two alternatives and the sunk cost of the old machine. The analysis is correct in respect of taking the differential cost savings between the two ...

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