Question

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 $66,900, the accumulated depreciation is $26,800, 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 $139,200. 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	$212,100		$212,100
Direct materials	$72,300		$72,300
Direct labor	50,200		—
Power and maintenance	4,700		24,800
Taxes, insurance, etc.	1,700		5,600
Selling and administrative expenses	50,200		50,200
Total expenses	$179,100		$152,900

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 zero "0".

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)	$	$	$

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

Differences in capacity between the two alternatives is​ (relevant/not relevant) to consider before a final decision is made.

Answer 1

The differential analysis of the two alternatives is presented below:

Differential Analysis
Continue with old machine(Alt 1)or Replace old machine (Alt 2)
	Continue with old machine (Alt 1)	Replace old machine(Alt 2)	Differential effect on income
Revenues:
Sales (5 years)	$10,60,500	$10,60,500	$0
Costs:
Purchase price	$0	-$1,39,200	-$1,39,200
Direct materials	-$3,61,500	-$3,61,500	$0
Direct labour	-$2,51,000	$0	$2,51,000
Power and maintainence	-$23,500	-$1,24,000	-$1,00,500
Taxes, insurance,	-$8,500	-$28,000	-$19,500
Selling and admin expenses	-$2,51,000	-$2,51,000	$0
Income	$1,65,000	$1,56,800	-$8,200

Based on the above analysis, it is recommended that the old machine should not be replaced as the differential income is negative. This means the incremental costs are more than the incremental savings. The savings is in the form of decrease in labour costs, however the increase in other costs as well as the purchase price offset the savings, hence it is recommended not to replace the old machine and continue with the old machine.