Relevance of equipment costs. Sparkles Ltd. has just today paid for and installed a special.

machine for polishing cars at one of its several outlets. It is the first day of the company’s fiscal year. The machine cost $25,000. Its annual operating costs total $18,200, exclusive of amortization. The machine will have a four-year useful life and a zero terminal disposal price.

After the machine has been used for a day, a machine salesperson offers a different machine that promises to do the same job at a yearly operating cost of $10,250, exclusive of amortization. The new machine will cost $28,700 cash, installed. The “old” machine is unique and can be sold outright for only $12,000, minus $2,400 removal cost. The new machine, like the old one, will have a four-year useful life and zero terminal disposal price.

Sales, all in cash, will be $170,000 annually, and other cash costs will be $123,000 annually, regardless of this decision.

For simplicity, ignore income taxes, interest, and present value considerations.

REQUIRED 1.

a. Prepare a statement of cash receipts and disbursements for each of the four years under both alternatives. What is the cumulative difference in cash flow for the four years taken together?

b. Prepare income statements for each of the four years under both alternatives. Assume straight-line amortization. What is the cumulative difference in operating income for the four years taken together? '

c. What are the irrelevant items in your presentations in requirements a and b? Why are they irrelevant?

2. Suppose the cost of the “old” machine was $1.1 million rather than $25,000. Nevertheless, the old machine can be sold outright for only $11,000, minus $2,200 removal cost. Would the net differences in requirements 1a and 1b change? Explain.

3. “To avoid a loss, we should keep the old machine.” What is the role of book value in decisions about replacement of machines?LO1