Jskinen 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 companys fiscal year. The machine cost

20 000. Its annual operating costs total 15 000, exclusive of depreciation. The machine

will have a four-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 9000, exclusive of depreciation. The new machine will cost 24 000 cash, installed. The old machine is unique and can be sold outright for only 10 000, minus 2000 removal cost. The new machine, like the old one, will have a four-year useful life and zero terminal disposal price.

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

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

Required

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

b Prepare income statements for each of the four years under both alternatives. Assume straight-line depreciation. What is the cumulative difference in operating profit for the four 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 1 million rather than 20 000. Nevertheless, the old machine can be sold outright for only 10 000, minus 2000 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 deci- sions about replacement of machines?