Micronteen bought a brand new machine exactly four years ago for £50,000. The machine had an estimated life of 10 years and annual operating costs of £45,000, including depreciation. Although the management of Micronteen are happy with the machine, recent advances in technology and ever-increasing pressure on profit margins have made it obsolete.

In view of this, with effect from January 1992 the machine had a book value of £30,000, a remaining operating life of 6 years, and it is felt that whenever it is sold the net residual value will be nil.

The operations manager is evaluating a proposal to acquire a new computerised machine to replace the original one. The new machine would cost £60,000 and reduce annual operating costs to £35,000, including depreciation. Because of expected further technological improvements, the manager believes the new machine will have an economic life of only 6 years and no residual value at the end of that time.

Before signing the papers authorising the acquisition of the new machine, the managing director (a marketing specialist) said that by his reckoning, the proposal was only a breakeven one. He calculated that over the six years of the life of the new machine, the savings in operating costs would amount to a total of £90,000; and that when this amount was set against the capital cost of the new machine of £60,000, together with the £30,000 loss on disposal of the old machine, the actual benefits of replacement were precisely zero.

After looking at these figures, the managing director rejected the proposal and commented that he was not impressed by any proposal that merely suggested a breakeven position. He wanted, he said, to be presented with projects that moved the business forward, not kept it standing still.

Micronteen provides for depreciation on the straight-line basis.

Required

(a) Evaluate the managing director’s analysis.

(b) Prepare a differential analysis of this proposal.