Question

Murl Plastics Inc. purchased a new machine one year ago at a cost of $78,000. Although the machine operates well, the president of Murl Plastics is wondering if the company should replace it with a new electronic machine that has just come on the market. The new machine would slash annual operating costs by two-thirds, as shown in the comparative data below:

  

	Present Machine			Proposed New Machine
Purchase cost new	$	78,000		$	117,000
Estimated useful life new		6	years		5	years
Annual operating costs	$	54,600		$	18,200
Annual straight-line depreciation		13,000			23,400
Remaining book value		65,000			—
Salvage value now		13,000			—
Salvage value in five years		0			0

  

In trying to decide whether to purchase the new machine, the president has prepared the following analysis:

  

Book value of the old machine	$	65,000
Less: Salvage value		13,000
Net loss from disposal	$	52,000

  

“Even though the new machine looks good,” said the president, “we can’t get rid of that old machine if it means taking a huge loss on it. We’ll have to use the old machine for at least a few more years.”

  

Sales are expected to be $273,000 per year, and selling and administrative expenses are expected to be $163,800 per year, regardless of which machine is used.

  

Required:

1.	Prepare a summary income statement covering the next five years, assuming the following:

  

a.	The new machine is not purchased.
b.	The new machine is purchased.
	(Leave no cells blank - be certain to enter "0" wherever required.)

      

2.	Compute the net advantage of purchasing the new product using relevant costs.

  

     

Answer 1

1.

a.

If the new machinery is not purchased:

.

Particulars Sales Less: Selling and administrative expenses Net Sales Less: Annual operating costs Less: Annual straight line depreciation Net Income Year 1 273,000 163,800 109,200 54,600 13,000 41,600 Year 2 273,000 163,800 109,200 54,600 13,000 41,600 Year 3 273,000 163,800 109,200 54,600 13,000 41,600 Year 4 273,000 163,800 109,200 54,600 13,000 41,600 Year 5 273,000 163,800 109,200 54,600 13,000 41,600

b.

If the new machinery is purchased:

Particulars Sales Less: Selling and administrative expenses Net Sales Less: Annual operating costs Less: Annual straight line depreciation Less: Net loss from Disposal Net Income Year 1 273,000 163,800 109,200 18,200 23,400 52,000 15,600 Year 2 273,000 163,800 109,200 18,200 23,400 Year 3 273,000 163,800 109,200 18,200 23,400 Year 4 273,000 163,800 109,200 18,200 23,400 Year 5 273,000 163,800 109,200 18,200 23,400 67,600 67,600 67,600 67,600

2.

Net Advantage:

Years Year 1 Year 2 Year 3 Year 4 Year 5 Total 5 year Summary Keep Old Machine Buy New Machine 41,600 15,600 41,600 67,600 41,600 67,600 41,600 67,600 41,600 67,600 208,000 286,000 Difference -26,000 26,000 26,000 26,000 26,000 78,000

Net advantage of purchasing the new machine is $ 78,000