Question

Differential Analysis for Machine Replacement

Kim Kwon Digital Components Company assembles circuit boards by using a manually operated machine to insert electronic components. The original cost of the machine is $62,100, the accumulated depreciation is $24,800, its remaining useful life is five years, and its residual value is negligible. On May 4 of the current year, a proposal was made to replace the present manufacturing procedure with a fully automatic machine that has a purchase price of $129,200. The automatic machine has an estimated useful life of five years and no significant residual value. For use in evaluating the proposal, the accountant accumulated the following annual data on present and proposed operations:

	Present Operations		Proposed Operations
Sales	$196,900		$196,900
Direct materials	$67,100		$67,100
Direct labor	46,600		—
Power and maintenance	4,300		23,000
Taxes, insurance, etc.	1,600		5,200
Selling and administrative expenses	46,600		46,600
Total expenses	$166,200		$141,900

a. Prepare a differential analysis dated May 4 to determine whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2). Prepare the analysis over the useful life of the new machine. If an amount is zero, enter "0". For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 4
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues:
Sales (5 years)	$	$	$
Costs:
Purchase price
Direct materials (5 years)
Direct labor (5 years)
Power and maintenance (5 years)
Taxes, insurance, etc. (5 years)
Selling and admin. expenses (5 years)
Income (Loss)	$	$	$

b. Based only on the data presented, should the proposal be accepted?

c. Differences in capacity between the two alternatives is   to consider before a final decision is made.

Answer 1

a.						Continue with old machine (Alternative 1)	Replace old machine (Alternative 2)	Differential effect on income (Alternative 2)
	Revenues:
	Sales (5 years)			(196900*5)	a	984500	984500	0
	Costs:
	Purchase price					0	129200	-129200
	Direct materials			(67100*5)		335500	335500	0
	Direct labor			(46600*5)		233000	0	233000
	Power and maintenance					21500	115000	-93500
						(4300*5)	(23000*5)
	Taxes,insurance etc.					8000	26000	-18000
						(1600*5)	(5200*5)
	Selling and administrative expenses					233000	233000	0
						(46600*5)	(46600*5)
	Total costs				b	831000	838700	-7700
	Income (loss)				a-b	153500	145800	-7700
b.	Proposal should not be accepted since accepting proposal results in a loss of $ 7700