Question

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of $36,000 and a remaining useful life of 4 years, at which time its salvage value will be zero. It has a current market value of $46,000. Variable manufacturing costs are $33,200 per year for this machine. Information on two alternative replacement machines follows. Cost Variable manufacturing costs per year Alternative A $121,000 22,900 Alternative B $114,000 18,100 Calculate the total change in net income if Alternative A, B is adopted. Should Xinhong keep or replace its manufacturing machine? If the machine should be replaced, which alternative new machine should Xinhong purchase? Complete this question by entering your answers in the tabs below. Alternative A Alternative B Xinhong Purchase Calculate the total change in net income if Alternative A is adopted. (Cash outflows should be indicated by a minus sign.) ALTERNATIVE A: INCREASE OR (DECREASE) IN NET INCOME Cost to buy new machine Cash received to trade in old machine Reduction in variable manufacturing costs Total change in net income < Alternative A Alternative B Σ .

Answer 1

Alternative A:

Cost to buy new machine: - $ 121,000

Cash received to trade in old machine: $ 46,000

Reduction in variable manufacturing costs: $ 10,300

Total change in 'net income': - $ 64,700 (see PS for a different and stricter view)

Alternative B: (assuming, the boxes to fill in are same as in Alternative A)

Cost to buy new machine: - $ 114,000

Cash received to trade in old machine: $ 46,000

Reduction in variable manufacturing costs: $ 23,100

Total change in 'net income': - $ 44,900 (see PS for a different and stricter view)

Xinhong will purchase Alternative B because the cash outflow is lesser than in Alternative A.

Working notes:

1. Reduction in variable manufacturing costs in Alternative A is: 33,200 - 22,900 = $ 10,300

2. Reduction in variable manufacturing costs in Alternative B is: 33,200 - 10,100 = $ 23,100

PS: If "the total change in net income", is to be interpreted strictly, it should mean that we shall consider depreciation, but not the costs of the alternatives, as well as the cash received to trade in the old machine. But as the expected useful lives or depreciation rates of Alternatives A and B are not provided, we cannot calculate depreciation. So, what we can work out is only the total net cash flow for the current year. For remaining years, the change would just be the Reduction in variable manufacturing costs (and change in depreciation, which is not provided). [This PS is for your academic interest].