Ibrahim Asafi, the general manager of the Coronado Company, 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.

Additional Information

a. Coronado uses straight-line amortization calculated on the difference between the initial equipment investment and the terminal disposal price 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, $120,000 is waste and scrap. The new equipment is expected to reduce scrap costs to $20,000

d. The new equipment is expected to reduce direct manufacturing labour costs by $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 $100,000.

f. Coronado 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 operation by 20%, reducing allocated rent by $8,000. The Coronado Company 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. 

Coronado estimates a required rate of return of 12% for this project.

Required:

1. On the basis of the net present value method, should Asafi replace the existing assembly equipment?

2. Suppose that next year is the last year Coronado will offer the attractive bonus plan currently in place. Asafi’s bonus hinges on short-run accrual accounting income for that year. Will Asafi be inclined to replace the Assembly Department equipment? Provide quantitative support for our answer.
 

Existing Assembly Equipment New Automated Assembly Equipment $1,200,000 5 years O years 5 years $0 Not acquired yet Not acquired yet Original cost Useful life Current age $1,100,000 11 years 6 years 5 years $600,000 $500,000 $200,000 $0 Useful life remaining Accumulated amortization Book value Current disposal price (in cash) Terminal disposal price (in cash, in 5 years) Average working capital needed $0 $120,000 $70,000 Current annual Assembly Department costs are as follow: Direct materials Direct manufacturing labour Amortization Maintenance and repairs Other operating costs Supervision (allocated as 10% of direct manufacturing labour costs) Allocated rent (based on space used) Allocate corporate overhead (based on direct manufacturing labour costs) Total $600,000 400,000 100,000 150,000 50,000 40,000 40,000 120,000 $1,500,000