Relevant Costs and Differential Analysis (LO4, 2)

College Station Bank paid $50,000 for a check-sorting machine in January 2008. The machine had an estimated life of 10 years and annual operating costs of $45,000, excluding depreciation. Although management is pleased with the machine, recent technological advances have made it obsolete.

Consequently, as of January 2012, the machine has a book value of $30,000, a remaining operating life of 6 years, and a salvage value of $0.

The manager of operations is evaluating a proposal to acquire a new optical scanning and sorting machine. The new machine would cost $90,000 and reduce annual operating costs to $25,000, excluding depreciation. Because of expected technological improvements, the manager believes the new machine will have an economic life of 6 years and no salvage value at the end of that life. Prior to signing the papers authorizing the acquisition of the new machine, the president of the bank prepared the following analysis:

Six-year savings [($45,000 — $25,000) x 6 years]...... $120,000 GOSIBOIMOWIMAGIIME S foie cic nusie. «ns donee Ogee (90,000)

Possiommisposalionold machine .. 5.2.6 cass enieienee (30,000)

Advantage (disadvantage) of replacement............ $ 0 After looking at these numbers, the manager rejected the proposal and commented that he was “tired of looking at marginal projects. This bank is in business to make a profit, not to break even. If you want to break even, go work for the government.”

Required

a. Evaluate the president’s analysis.

b. Prepare a differential analysis of six-year totals for the old and the new machines.

c. Speculate on some limitations of the model or other issues that might be a factor in making a final decision.