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Unformatted text preview: e relevant cost of replacing the equipment would be $80y – $600,000 + $4,200,000. TechMech would want to upgrade if $140y + $2,700,000 < $80y – $600,000 + $4,200,000 $60y < $900,000 y < $900,000 ¸ $60 = 15,000 units or upgrade when y < 15,000 unit s (or 5,000 per year for 3 years) and replace when y > 15,000 units over 3 years. When production and sales vo lume is low (less than 5,000 per year), the higher operating costs under the upgrade option are more than offset by the savings in capital costs from upgrading. When production and sales vo lume is high, the higher capital costs of replacement are more than offset by the savings in operating costs in the replace option. 11­16 4. Operating inco me for the first year under the upgrade and replace alternat ives are shown below: Year 1 Upgrade Replace (1) (2) Revenues (6,000 ´ $500) $3,000,000 $3,000,000 Cash operating costs $140; $80 per desk ´ 6,000 desks per year 840,000 480,000 a Depreciat ion ($900,000 + $2,700,000) ¸ 3; $4,200,000 ¸ 3 1,200,000 1,400,000 Loss on disposal of o ld equipment (0; $900,000 – $600,000) 0 300,000 Total costs 2,040,000 2,180,000 Operating Inco me $ 960,000 $ 820,000 a The book value of the current production equipment is $1,500,000 ´ 3 ¸ 5 = $900,000; it has a remaining useful life of 3 years. First­year operating inco me is higher by $140,000 under the upgrade alternat ive, and Dan Doria, with his one­year horizon and operating income­based bonus, will choose the upgrade alternat ive, even though, as seen in requirement 1, the replace alternat ive is better in the lo ng run for TechMech. This exercise illustrates the possible conflict between the decisio n model and the performance evaluation model. 11­17 11­29 (20 min.) Special Order. 1. Revenues fro m special order ($25 ´ 10,000 bats) 1 Variable manufacturing costs ($16 ´ 10,000 bats) Increase in operating inco me if Ripkin order accepted 1 $250,000 (160,000) $ 90,000 Direct materials + Direct manufacturing labor + Variable manufacturing overhead = $12 + $1 + $3 = $16 Louisville should accept Ripkin’s special order because it increases operating i...
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