Relevant costs, capital budgeting. (N. Melumad, S. Reichelstein, adapted) The Special Products Division (SPD) of Plastics Unlimited makes specially designed night goggles. Its main production machine broke down on January 1, 2008, and was no longer usable. SPD’s manager requested $384,000 to acquire a new machine. Corporate management responded by requesting an analysis of the acquisition as well as an analysis of closing down SPD. SPD’s 2007 income statement is as follows:

Special Products Division Income Statement for 2007 Sales (60,000 units) $ l ,440,000 Deduct: Costs:
Variable production costs $924,000 Fixed production costs:*
Machine amortization $36,000 Patent amortization 30,000 Machine maintenance 24,000 Building space 24,000 Manager’s salary 66,000 Other fixed costs 18,000 Total fixed production costs 198,000 Variable marketing costs 156,000 Total costs 1,278,000 Operating income $ 162,000 *That do not vary with units produced and sold.
The externally reported book values ofthe division assets as of December 31, 2007, are Cash $228,000 Machine 72,000 Patent 150,000 Total $450,000 All of SPD’s transactions are cash transactions, and the division maintains no inventories. The contribution margin is expected to remain the same over the next five years if SPD continues to produce and sell goggles.
To make the goggles, the company had to acquire a patent three years ago for $240,000. The patent is being amortized (that is, written off on the income statement) evenly over its lifetime. If the company were to shut down SPD, the patent could be sold for $282,000 to an external buyer.
SPD purchased the existing machine three years ago for $ 180,000. It is amortized on a straight-line basis over five years. The current disposal price ofthe broken machine is $4,800.
The new machine has a useful life of five years and an expected disposal price of $60,000. It would be amortized under the straight-line method. Maintenance of the new machine would require $30,000 per year. Machine maintenance costs would not be incurred if SPD is closed down.
SPD uses 1,000 square metres of building space and is charged $24 per square metre by corporate management. If SPD is eliminated, the space can be rented externally for $36 per square metre.
Plastics Unlimited needs an assistant manager in another larger department. If SPD closes, its manager will take the assistant manager position at an annual salary of $72,000. If SPD continues operations, Plastics Unlimited will have to fill the assistant manager position with an outsider at an annual salary of $78,000.
Other fixed costs consist of miscellaneous items such as insurance and indirect labour that would remain at the same levels if SPD continues to produce the goggles and would not be incurred if SPD is closed down.
The firm uses a required rate ofreturn of 16%. Ignore income taxes.
Instructions Form groups ofthree students to complete the following requirements.
Required 1. On the basis ofthe net present value criterion, should Plastics Unlimited purchase the new machine or close down SPD?
2. Suppose the manager making the decision is compensated on the basis of operating income earned by all divisions ofPlastics Unlimited after gain or loss on disposal of assets. The man¬
ager will retire at the end of 2008. Which decision would the manager favour? Explain.