Sharpton Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plantwide predetermined overhead rate based on direct labour-hours. On December 10, 2015, the company's controller made a preliminary estimate of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $3,402,000 and the estimated 63,000 total direct labour-hours for 2016:

$3,402,000 / 63,000 hour = %54 per direct labour hour

With the purchase of an automated milling machine, we estimated that the automated equipment would eliminate the need for about 6,000 direct labour-hours a year. The wage rate in the milling area averages about $32 per hour. Fringe benefits raise that figure to about $41 per hour. Next year the overhead rate will be about $54 per direct labour hour. So including fringe benefits and overhead, the cost per direct labour-hour is about $95. Since you can save 6,000 direct labour-hours per year, the cost savings would amount to about $570,000 a year, and our 60-month lease plan would require payments of only $348,000 per year.

Shortly after this meeting, Reynolds informed the company's controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realized that this decision would require a recomputation of the predetermined overhead rate for 2016, since the decision would affect both the manufacturing overhead and the direct labour-hours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $348,000, the new machine would also require a skilled technician/programmer who would have to be hired at a cost of $50,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labour-hours for the year from the levels that had initially been planned.

When the revised predetermined overhead rate for 2016 was circulated among the company's top managers, there was considerable dismay.

1. Recompute the predetermined rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for 2016.

2. What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine?

3. Why would managers be concerned about the new overhead rate?

4. After seeing the new predetermined overhead rate, the production manager admitted that he probably wouldn't be able to eliminate all of the 6,000 direct labour-hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labour savings would only be about 2,000 hoursone worker. In the light of this additional information, evaluate the original decision to acquire the automated milling machine from Central Robotics.