4. Question 4 Drop or Keep - The Caledonian Company (provide Solutions)

The Caledonian Company purchased a machine three years ago for 180,000. Depreciation using a straight line basis, assuming a life of six years and with no residual value, has been recorded each year in the financial statements. The present written-down value of the equipment is 90,000 and it has a remaining life of three years. Management is considering replacing this machine with a new machine that will reduce variable operating costs. The new machine will cost 70,000 and will have an expected life of three years with no residual value. The variable operating costs are 3 per unit of output for the old machine and 2 per unit of output for the new machine. It is expected that both machines will be operated at a capacity of 20,000 units per annum. The revenues from the output of both machines will, therefore, be identical. The current disposal value of the old machine is 40,000 and it will be zero in three years time.

REQUIREMENT

Advise the directors of The Caledonian Company as to their optimum policy in this situation. Show all calculations and comment briefly on your treatment of each item(State each item is relevant cost or not relevant cost). State all assumptions made.