Question

The TechHelp Company produces and sells 7,000 modular computer desks per year at a selling price of $700 each. It's current production equipment, purchases for $1,350,000 and with a five-year useful life, is only two years old. It has a terminal disposal value of $0 and is depreciated in a straight-line basis.The equipment has a current disposal price of $400,000. However, the emergence if a new molding technology has left TechHelp to co sider either upgrading or replacing the production equipment. The following table presents data for the two alternatives.

basis. For simpli © Data Table w ce it? Show you the table, leav Upgrade Replace $ 3,000,000 $4,600,000 155 $ e subtracted.) One-time equipment costs Variable manufacturing cost per desk Remaining useful life of equipment (years) Terminal disposal value of equipment Difference 0$ ow Print Done

All equipment costs will continue to be depreciated on a straight-line basis. For simplicity, ignore taxes and the time value of money.

1.

Answer 1

	Upgrade	Replace	Difference
One time equipment costs	3,000,000	4,600,000	1,600,000
Variable manufacturing cost	3,255,000	1,575,000	(1,680,000)
Current Disposal Value	-	(400,000)	(400,000)
Total Relevant costs	6,255,000	5,775,000	(480,000)
Should replace, since lower cost
2.Maximum cost = 6,255,000+400,000-1575000 = $5,080,000
3.Indifference point = Difference in Fixed costs/(Difference in variable cost per unit)
=(1,200,000)/(155-75)
15000	units
Hence, Upto 5000 units per year - Upgrade
Above 5000 - Replace
4.Choose Upgrade as depreciation costs will be lower leading to higher operating income in Year 1

B C D Upgrade Replace Difference 3000000 4600000 =C2-B2 |=155*7000*3 =75*7000*3 =C3-B3 -400000 =C4-B4 =SUM(B2:34) =SUM(C2:04) |=SUM(D2:04) | А 1 2 One time equipment costs 3 Variable manufacturing cost 4. Current Disposal Value 5 Total Relevant costs 6 Should replace, since lower cost 7 8 2. Maximum cost = 6,255,000+400,000-1575000 = $5,080,000 9 10 3.Indifference point = Difference in Fixed costs/(Difference in variable cost per unit) 11 =(1,200,000)/(155-75) 12 =(1200000)/(155-75) 13 Hence, Upto 5000 units per year - Upgrade 14 Above 5000 - Replace units 15 16 4. Choose Upgrade as depreciation costs will be lower leading to higher operating income in Year 1