Relevant costs, replacement decisions performance evaluation.

(30 minutes) Kjell Svensson, the general manager of Hoglund, AB, is contemplating replacing the existing assembly-line equipment in the Assembly Department with automated assembly equipment. Production output and revenues will be unaffected by the replacement decision.

Transactions related to the capital investment are cash transactions that would occur today. bht7

a. Hoglund uses straight-line depreciation calculated on the difference between the initial equipment investment and the terminal disposal value of the equipment.

b. The new equipment will produce output more swiftly. Therefore, the average working-capital investment, if the new equipment is purchased, will decrease.

c. Of the total direct materials costs, EUR 120,000 is waste and scrap.
The new equipment is expected to reduce scrap costs to EUR 20,000.

d. The new equipment is expected to reduce direct manufacturing labour costs by EUR 150,000 each year.

e. Maintenance and repairs on the old equipment have been excessive.
If the new equipment is acquired, maintenance and repair costs are expected to decrease to EUR 100,000.

f. H6glund collects all supervision costs for all manufacturing departments in the plant into one cost pool. These costs are then allocated to departments on the basis of direct manufacturing labour costs. The Assembly Department has only one supervisor currently. The supervisor will continue in her current position if the new equipment is purchased.
g. The new equipment will reduce the space required for assembly operations by 20%, reducing allocated rent by EUR 8,000. Hogiund has no alternative uses for this extra space.
h. Corporate overhead costs are allocated to each department at 30% of direct manufacturing labour costs of each department.
Svensson estimates a required rate of return of 12% for this project.
REQUIRED i3 On the basis of the net present-value method, should Svensson replace the existing assembly equipment?
Suppose that next year is the last year Hoglund will offer the attractive bonus plan currently in place. Svensson’s bonus hinges on short-run accounting income for that year. Will Svensson be inclined to replace the Assembly Department equipment? Provide quantitative support for your answer.
What non-financial and qualitative factors should Svensson consider in coming to a decision?

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EXISTING ASSEMBLY EQUIPMENT EUR 1,100,000 11 years NEW AUTOMATED ASSEMBLY EQUIPMENT EUR 1,200,000 5 years 0 years Original cost Useful life Current age Useful life remaining Accumulated depreciation Book value 6 years 5 years EUR 600,000 EUR 530,000 Current disposal value (in cash) EUR 200,000 Terminal disposal value (in cash, in 5 years) EUR 0 Average working capital needed EUR 120,000 Current annual Assembly Department costs are as follows: Direct materials 5 years EUR O Not acquired yet Not acquired yet EUR 0 EUR 70,000 EUR 600,000 400,000 100,000 150,000 50,000 40,000 40,000 120,000 EUR 1,500,000 Direct manufacturing labour Depreciation Maintenance and repairs Other operating costs Supervision (allocated as 10% of direct manufacturing labour costs) Allocated rent (based on space used) Allocated corporate overhead (based on direct manufacturing labour costs) Total