Tony Hawk (TH) Ltd. is currently faced with a critical decision regarding its production equipment. Tony Hawk (TH) is evaluating two options for its production equipment: upgrading or replacing. The company manufactures and sells 7,500 heaters every year, each priced at $920. The current production equipment, which was acquired at a cost of $2,150,000, has been in use for just two years and is subject to straight-line depreciation over a five-year useful life. Furthermore, it possesses no terminal disposal value, but it can be currently sold for $650,000.

The following table presents data for the two alternatives:

A	B	C
Choice:	Upgrade	Replace
One-time equipment costs:	$3,500,000	$5,200,000
Variable manufacturing cost per Heater	$180	$90
Remaining useful life of equipment (years)	3	3
Terminal disposal value of equipment	0	0

Required:

1. Prepare schedule, for the remaining 3 years, reflecting whether TH should upgrade its production line or replace it?

2. Assuming that all other data are as given previously stated, calculate TH's maximum allowable cost for replacement versus upgrading, where there is a negotiable one-time replacement of the production equipment?

3. Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but that the production and sales quantity is not known. For what production and sales quantity would TH:

• Upgrade the equipment?
• Replace the equipment?

4. Nick Koe is TH's manager, who will be relocated after one year and whose bonus is based on operating income. Given unchanged data, evaluate Nick's decision-making process and which alternative he would choose, taking into account his relocation and bonus dependence.

5. By reference to the above data:

• Explain whether historical costs and future costs are relevant?
• Differentiate between quantitative and qualitative aspects in the process of decision?making?

Here are examples to help you in you answering the 5 questions above:

Unit 6 - Relevant Cost and Decisionmaking Relevance and the Decision-making Process 1. A company has an inventory of 1,000 assorted parts for a line of missiles that has been discontinued. The inventory cost is $80,000. The parts can be either (a) remachined at total additional costs of $30,000 and then sold for $35,000, or (b) sold as scrap for $2,000. Which action should be taken. - 2. A truck, costing $100,000 and uninsured, is wrecked its first day in use. It can be either (a) disposed of for $10,000 cash and replaced with a similar truck costing $102,000 or (b) rebuilt for $85,000 and thus be brand-new as far as operating characteristics and looks are concerned. What should be done? Unit 6 - Relevant Cost and Decision-making Relevance and the Decision-making Process Activity #6.2 #1 Option (a)-- Remachined $$ Additional cost -30000 Additional Revenue 35000-*+ Net Inflow 5000 Option (b)--Sold for Scrap 2000 Choice: Option (a) Qualitative factors not considered Activity #6.2 #2 Option (a) Disposal $$ Cash Disposal 10000 New Truck -102000 Net Flow -92000 Option (b)--Rebuilt -85000 Choice--Option (b) Qualitative factors not consideredEquipment Replacement Caribo is considering replacing an old computer with a new model. The cost of the new model is $46,000 while the old was acquired at a cost of $20,000. Summary data of the old and new machines are as follows: Table Existing Machine Replacement Machine Original cost $ 20,000 (sunk) $46,000 Useful life in years 8 years 5 years Current age in years 3 years 0 years Useful life remaining in years 5 years 5 years Accumulated depreciation $ 4,000 Not yet acquired Book value $ 16,000 Current disposal price (in cash) $ 4,000 Terminal disposal price (in cash 2 years from now) $ 2,000 SO Annual variable expenses $ 50,000 $40,000 Sales (Revenue)/year $300000 $300000 Fixed expenses /year $200000 $200000 Req: 1)choose option 2) Calculate Caribo's maximum allowable cost for replacement versus remaining with the existing mach, where there is a negotiable one-time replacement of the computer? p to add notesUnit 6 - Relevant Cost and Decision-making Five Years Together Retain Sales (Revenue) $ 1,500,000 Fixed expenses (250,000) Variable expenses (250,000) Old machine book value: Periodic write off as depreciation (16,000) Lumpsum write off Current disposal of old machine New machine cost, written off periodically as depreciation Total operating costs 5 516,000 Net income I 5 984,000 Replace S 1,500,000 (250,000) (200,000) (16,000) 4,000 (46,000) S 508,000 $ 992,000 Difference 50,000 4,000 (46,000) $ 8,000 $ 8,000 Sample question Calculate Caribo's maximum allowable cost for replacement versus retaining with the existing mach, Where there is a negotiable one-time replacement of the computer? Suppose the Cap. Ex. to replace the eqpt. is SX, substituting for the one time capital cost of replacement: 200000 -4000 + X. The relevant cost of retaining is 266000. - 200000-4000 + X