a. Calculate the book loss (i.e., the loss for financial reporting purposes) that Callaway references regarding the disposal (i.e., the outright sale) of the old machine. What effect should the book value have on the decision to purchase the new machine? How will external users, such as shareholders, likely react to this information? What incentive does Watson have in representing the length of time for retooling? How might the present decision affect customer relations? What general issue regarding incentive effects and the design of management accounting control systems is raised by this example?

b. Expand on Callaway’s criticisms from a strategic perspective. For example, what does he mean by “squeezing margins”? What economic assumption regarding price elasticity of demand is XYZ making for its products? How does XYZ balance its desire to gain market share through cost efficiencies with the “commitment” it made to shareholders regarding the original machine?

c. Prepare a response to the two questions raised by Smith regarding strategic/qualitative considerations associated with the proposed investment: (1) What additional nonfinancial/strategic factors (beyond those discussed in 4(a) and 4(b)) might bear on the decision facing XYZ Company? (2) How could such factors (if any) be formally incorporated into a capital budgeting analysis? To the extent possible, support your position by offering several additional qualitative/strategic considerations and by referencing the appropriate literature (e.g., the literature pertaining to “multi-criteria decision making” models as applied to a capital budgeting context).

XYZ Company was formed in the United States seven years ago by Jim Smith, Marsha Chang, and Earl Watson, who together purchased a commercial machine shop that had been in business for more than 40 years but, at the time of the acquisition, was feeling pressure from a variety of new entrants into the markets in which the machine shop competed. Smith had a distinguished military career and felt he could use the skills he acquired in the military to help this business return to its previously highly profitable state. Smith currently serves as the president and CEO of the company. XYZ produces three primary product lines, all of which are made of brass and are water-related: flow controllers, valves, and pumps. Marsha Chang, a long-time friend of Smith and his family, and a practicing CPA (Certified Public Accountant) and CMA® (Certified Management Accountant), joined the company as its CFO shortly before the formation of XYZ. Earl Watson, a high school friend of Smith, had worked as the manufacturing supervisor at the company for the past 10 years and, at the request of Smith, decided to stay onboard after the formation of XYZ. Over the past several years, Watson had toyed with the idea of introducing more technologically up to-date equipment that, he thought, could help ameliorate the competitive position of the company. Recently, Chang instituted an activity-based costing (ABC) system and a “bare-bones” Enterprise Resource Planning (ERP) system that, among other things, helped the company assess customer profitability and price its products more competitively. A new marketing manager, Maria Sanchez, was hired last year to develop and implement an aggressive product-promotion plan.