Question

The Dowling Company produces and sells 5,900 modular computer desks per year at a selling price of $480 each. Its current production​ equipment, purchased for $1,750,000 and with a​ five-year useful​ life, is only two years old. It has a terminal disposal value of​ $0 and is depreciated on a​ straight-line basis. The equipment has a current disposal price of $650,000. ​However, the emergence of a new molding technology has led Dowling to consider either upgrading or replacing the production equipment. The following table presents data for the two​ alternatives:

	Upgrade		Replace
One-time equipment costs	$2,400,000		$3,900,000
Variable manufacturing cost per desk	$120		$60
Remaining useful life of equipment (years)	3		3
Terminal disposal value of equipment	$0		0

All equipment costs will continue to be depreciated on a​ straight-line basis.

For​ simplicity, ignore income taxes and the time value of money.

1. Should

DowlingDowling

upgrade its production line or replace​ it? Show your calculations. ​(Only complete the necessary answer​ boxes.)

	Over 3 years		Difference
	Upgrade	Replace	in favour of Replace
Cash operating costs
Current disposal price
One time capital costs, written off
periodically as depreciation
Total relevant costs

Answer 1

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The Dowling Company
Workings
Calculation of Cash operating costs	Upgrade	Replace	Note
Annual production	5,900.00	5,900.00	A
Variable manufacturing cost per desk	120.00	60.00	B
Annual Variable manufacturing cost	708,000.00	354,000.00	C=A*B
Number of years	3.00	3.00	D
Cash operating costs of 3 years	2,124,000.00	1,062,000.00	E=C*D
Final Answer
	Over 3 years		Difference
Particulars	Upgrade	Replace	in favor of Replace
Cash operating costs	2,124,000.00	1,062,000.00	(1,062,000.00)	See E
Current disposal price	-	(650,000.00)	(650,000.00)
One time capital costs, written off periodically as depreciation	2,400,000.00	3,900,000.00	1,500,000.00
Total relevant costs	4,524,000.00	4,312,000.00	(212,000.00)
There is savings of $ 212,000 if the equipment is replaced. So it should be replaced.