Equipment replacement, relevant costs, sensitivity analysis. The engineering department LI of an automotive supplier specialized in manufacturing seating systems has developed a ee $600,000 machine for assembling school b liners. The machine has been used to produce cash outflows, developed ’ Bee DOS RPMs Bee TELS. ;

machine, $660,000 only one batch of 1,000 units so far (prototypes). The company will amortize the $600,000 initial machine investment evenly over five years, after which production of the recliners will be stopped. The company’s expected annual costs will be direct materials, $300,000; direct manufacturing labour, $120,000; and variable manufacturing overhead, $240,000. Variable manufacturing overhead varies with direct manufacturing labour costs. Fixed manufacturing overhead, exclusive of amortization, is $90,000 annually, and fixed marketing and administrative costs are $45,000 annually.

A German manufacturer of special-purpose machines informs the engineering department manager that in two weeks he can deliver a new machine that is ideally suited for assembling recliners. This new machine is clearly superior because it reduces the use of direct materials by 10% and produces twice as many units per hour. It will cost $500,000 and will have a zero terminal disposal price at the end of five years.

Production and sales of 25,000 units per year (sales of $1,200,000) will be the same whether the company uses the old machine or the new machine. The current disposal price of the internally developed machine is $60,000. Its terminal disposal price in four years will be

$30,000.

REQUIRED 1. Assume that the required rate of return is 16%. Using the net present value method, show whether the new machine should be purchased. What is the role of the book value of the old machine in the analysis?

2. What is the payback period for the new machine?

. As the manager who developed the $600,000 old machine, you are trying to justify not buying the new $500,000 machine. You question the accuracy of the expected cash operating savings. By how much must these cash savings fall before the point of indifference—

the point where the net present value of investing in the new machine reaches zero?

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