XYZ Manufacturing Company is currently manufacturing its product on a machine that is fully depreciated for tax purposes and that has a book value of $10,000 (it was purchased for $30,000 20 years ago). The costs of the product are as follows

: Item Unit costs

Labor, direct $4.00

Labor, indirect 2.00

Variable overhead 1.50

Fixed overhead 2.50

Total. $10.00

In the past year 1,000 units were produced and sold for $18 per unit. It is expected that the old machine can be used indefinitely. An equipment manufacturer has offered to accept the old machine as a trade-in for a new version. The new machine would cost $60,000 after allowing $15,000 for the old equipment.

The projected costs associated with the new machine are as follows:

Item Unit costs

Labor, direct $2.00

Labor indirect 3.00

Variable overhead 1.00

Fixed overhead 3.25

Total. 9.25

The fixed overhead costs are allocations from other departments plus the depreciation of the equipment. The old machine could be sold on the open market now for $5,000. Ten years from now it is expected to have a salvage value of $1,000.

The new machine has an expected life of ten years and an expected salvage of $10,000. The current corporate income tax rate is 0.40, and the capital gain tax rate is 0.25. Any salvage from sale will result in a capital gain at the time of retirement. (For tax purposes, the entire cost may be depreciated in ten years using straight-line depreciation.) The appropriate after-tax time discount rate for this project is 0.10.

It is expected that future demand of the product will stay steady at 1,000 units per year.

Questions

1) Should the equipment be acquired?

2) If the product can be purchased at a cost of $7.80 per unit from a reliable supplier, should it be purchased or made? Explain.

Please provide step by step solutions