Special People Industries (SPI) is a nonprofit organization that employs only people with physical or mental disabilities. One of the organization’s activities is to make cookies for its snack food store. Several years ago, Special People Industries purchased a special cookie-cutting machine. As of December 31, 20x0, this machine will have been used for three years. Management is considering the purchase of a newer, more efficient machine. If purchased, the new machine would be acquired on December 31, 20x0. Management expects to sell 300,000 dozen cookies in each of the next six years. The selling price of the cookies is expected to average $1. 15 per dozen.
Special People Industries has two options: continue to operate the old machine or sell the old machine and purchase the new machine. No trade-in was offered by the seller of the new machine. The following information has been assembled to help management decide which option is more desirable.
| Old | New |
| Machine | Machine |
Original cost of machine at acquistion | $80,000 | $120,000 |
Remaining useful lite as of December 31 20x0 | 6 years | 6 years |
Expected annual cash operating expenses | ||
Variable cost per dozen | $.38 | $.29 |
Total fixed costs | $21,000 | $11,000 |
Estimated cash value of machines: | ||
December 31,20x0 | $40,000 | $120,000 |
December 31 20x6 | $ 7,000 | $ 20.000 |
Assume that all operating revenues and expenses occur at the end of the year.
Required:
1. Use the net-present-value method to determine whether Special People Industries should retain the old machine or acquire the new machine. The organization’s hurdle rate is 16 percent.
2. Independent of your answer to requirement (1), suppose the quantitative differences are so slight between the two alternatives that management is indifferent between the two proposals. Write a memo to the president of SPI that identifies and discusses any nonquantitative factors that management should consider.
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