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Sam Anderson, the production manager at Frothingham Company, purchased a cutting machine for the company last year. Six months after the purchase of the cutting
Sam Anderson, the production manager at Frothingham Company, purchased a cutting machine for the company last year. Six months after the purchase of the cutting machine, Sam learned about a new cutting machine that is more reliable than the machine that he purchased. The following information is available for the two machines: @ (Click the icon to View the data.) ti Requirements (a) Should Sam Anderson replace the old machine with the new machine? Explain, listing all relevant costs. (b) What costs should be considered as sunk costs for this decision? (c) What other factors may affect Anderson's decision? Data table CATEGORY OLD MACHINE NEW MACHINE Acquisition cost $ 300,000 $ 370,000 Remaining life 5 years 5 years Salvage value now $ 105,000 --- Salvage value at the end of 5 years $ 4,500 $ 6,000 Annual operating costs for the old machine are $170,000. The new machine will decrease annual operating costs by $85,000. These amounts do not include any charges for depreciation. Frothingham Company uses the straight-line depreciation method. These estimates of operating costs exclude rework costs. The new machine will also result in a reduction in the defect rate from the current 4% to 1%. All defective units are reworked at a cost of $1 per unit. The company, on average, produces 100,000 units annually. Requirement (a) Should Sam Anderson replace the old machine with the new machine? Explain, listing all relevant costs. Select the relevant costs of purchasing a new machine, enter the relevant amount for each item and compute the cumulative cash savings/(additional costs). (Use parentheses or a minus sign to show costs and a net additional cost. Leave unused cells blank.) Relevant amount Salvage value of old machine after 5 years -4500 Salvage value of new machine after 5 years 6000 Change in operating costs over 5 years :I Reduction in rework costs :| Net acquisition cost of new machine Cumulative cash savings/(additional costs) Sam Anderson should acquire the new machine because it will result in lower total relevant costs . Requirement (b) What costs should be considered as sunk costs for this decision? (Leave unused cells blank.) Sunk costs: Original cost of old machine Requirement (c) What other factors may affect Anderson's decision? (Leave unused cells blank.) What is the cost of capital used to discount future cash ows? Will sales increase because of lower defects with the new machine? : E E
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