Relevance of equipment costs. (30-40 minutes) Jaaskinen, Oy, 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 FMk 20,000. Its annual operating costs total FMk 15,000, exclusive of depreciation. The machine will have a 4-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 FMk 9,000, exclusive of depreciation. The new machine will cost FMk 24,000 cash, installed. The ‘old’ machine is unique and can be sold outright for only FMk 10,000, minus FMk 2,000 removal cost. The new machine, like the old one, will have a 4-year useful life and zero terminal disposal price.

Sales, all in cash, will be FMk 150,000 annually, and other cash costs will be FMk 110,000 annually, regardless of this decision.

For simplicity, ignore income taxes, interest and present-value considerations. lop52 REQUIRED 1.

(a) Prepare a statement of cash receipts and disbursements for each of the 4 years under both alternatives. What is the cumulative difference in cash flow for the 4 years taken together?

(b) Prepare income statements for each of the 4 years under both alternatives. Assume straight-line depreciation. What is the cumulative difference in operating profit for the 4 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 FMk 1 million rather than FMk 20,000. Nevertheless, the old machine can be sold outright for only FMk 10,000, minus FMk 2,000 removal cost. Would the net differences in requirements 1 and 2 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?