Vachon Company

Vachon Company is considering a proposal that suggests replacing a machine to keep cows warm. The company operates a large dairy farm in the Cornwall area of Ontario and serves the Ottawa area.

The machine that the company proposes to purchase from a supplier sells for $140,000 and has a 5 year life span after which it can be sold for $14,000. If this piece of equipment is purchased, its annual operating costs will be $50,000 compared to operating costs of $80,000 for the current machine, a savings of $30,000 per year. This savings is mainly due to the fact that the new equipment requires much less energy than the current equipment. If the new equipment is not purchased, the current equipment can be used for another 5 years, after which it can be sold for $4,000. The market value of the current equipment is $35,000 and the supplier is willing to purchase it at that price which would bring the net cost for the new equipment to $105,000.

The technical department was therefore asked to prepare a study that would assist the directors in their decision on what action to take. The study concluded that the capital cost was 10%. The current equipment cost $95,000 and the accumulated depreciation on this equipment is $56,000.

Table 1 in the Appendix shows data from the company's financial statements for the past year.

Question:

What decision would you advise the president of the Vachon company? (Prepare in report form).

As a sensitivity analysis, the president would like to know what the indifference threshold is between the two options? (To calculate the indifference threshold, try to calculate the amount of annual savings for the two options to be equal)

Table 1

Condensed Statement of Results for Last Year

Net sales $10,728,426

Expenses and costs. 8,277,294

Income before taxes ..2,451,132

Provision for income taxes001 245,430

Net income001 205,702

Condensed Balance Sheet

at the end of last year

ASSETS

Current assets ........... $6,012,698

Fixed assets (net) ...........8 478 420

Other assets ..........302 982

Total assets ..........14 884 100

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities ...... $1,860,654

Mortgage bonds at 3%001 000 000

Share capital ........ $2,000,000

Retained earnings ........10 023 446

Total liabilities and shareholders' equity ....... $14,884,100

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