Note that this result can also be obtained by taking

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Unformatted text preview: and find the new machine before buying the o ld machine? Replacing the o ld machine one day later at a loss ma y make the manager appear inco mpetent to his or her superiors. If the manager’s bosses have no knowledge of the better machine, the manager may prefer to keep the exist ing machine rather than alert his or her bosses about the better machine. 11­15 11­28 (30 min.) Equipment upgrade versus replacement. 1. Based on the analysis in the table below, TechMech will be better off by $180,000 over three years if it replaces the current equipment. Comparing Relevant Costs of Upgrade and Replace Alternatives Cash operating costs $140; $80 per desk ´ 6,000 desks per yr. ´ 3 yrs. Current disposal price One time capital costs, written off periodically as depreciation Total releva nt costs Over 3 years Upgrade Replace (1) (2) $2,520,000 $1,440,000 (600,000) 4,200,000 $5,040,000 Difference in favor of Replace (3) = (1) – (2) $1,080,000 600,000 (1,500,000) $ 180,000 2,700,000 $5,220,000 Note that the book value o f the current machine ($900,000) would eit her be written o ff as depreciat ion over three years under the upgrade option, or, all at once in the current year under the replace option. Its net effect would be the same in both alternat ives: to increase costs by $900,000 over three years, hence it is irrelevant in this analysis. 2. Suppose the capital expenditure to replace the equipment is $X. Fro m requirement 1, column (2), subst ituting for the one­t ime capit al cost of replacement, the relevant cost of replacing is $1,440,000 – $600,000 + $X. From column (1), the relevant cost of upgrading is $5,220,000. We want to find X such that $1,440,000 – $600,000 + $X < $5,220,000 (i.e., TechMech will favor replacing) Solving the above inequalit y gives us X < $5,220,000 – $840,000 = $4,380,000. TechMech would prefer to replace, rather than upgrade, if the replacement cost of the new equipment does not exceed $4,380,000. Note that this result can also be obtained by taking the original replacement cost of $4,200,000 and adding to it the $180,000 difference in favor of replacement calculated in requirement 1. 3. Suppose the unit s produced and so ld over 3 years equal y. Using data fro m requirement 1, column (1), the relevant cost of upgrade would be $140y + $2,700,000, and from co lumn (2), th...
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