Chavez Digital Machining’s performance for the first 11 months of the year has been a surprise with sales and profits somewhat above expectations. On December 20, just prior to the holiday break, Patrick Olmec faced the decision of scrapping some old equipment and replacing it. The old equipment had a book value of $400,000 but could be sold for only $250,000. The new machinery had a cost of

$1,500,000 and was expected to produce net annual savings in cash operating costs of $180,000 over a 10-year life. The investment predicts returns higher than the minimum return required by the company.

Olmec’s year-end bonus is computed on the basis of company profitability.

Required

a. Discuss the conflict that sometimes arises in business between decision making and performance evaluation.

b. Should Olmec acquire the new machinery? Why? Show computations to support your answer.

Ignore taxes and the time value of money.