The Clampton Company is considering the purchase of a new machine to perform operations currently being performed on different, less efficient equipment. The purchase price is $110,000, delivered and installed. A Clampton production engineer estimates that the new equipment will produce savings of $30,000 in labor and other direct costs annually, compared with the present equipment. He estimated the proposed equipment's economic life at five years, with zero salvage value. The present equipment is in good working order and will last, physically, for at least ten more years. The company requires a return of at least 10 percent before taxes on an investment of this type. Taxes are to be disregarded.
a. Assuming the present equipment has zero book value and zero resale value, should the company buy the proposed piece of equipment?
b. Assuming the present equipment is being depreciated at a straight-line rate of 10 percent, that is, it has a book value of $40,000 (cost, $80,000; accumulated depreciation, $40,000) and has zero net resale value today, should the company buy the proposed equipment? The Clampton Company decides to purchase the equipment, hereafter called Model A. Two years later, even better equipment (called Model B) is available on the market and makes the other equipment completely obsolete, with no resale value. The Model B equipment costs $150,000 delivered and installed, but it is expected to result in annual savings of $40,000 over the cost of operating the Model A equipment. The economic life of Model B is estimated to be five years. It will be depreciated at a straight-line rate of 20 percent.
c. What action should the company take?
d. The company decides to purchase the Model B equipment, but a mistake has been made somewhere, because good equipment, bought only two years preViously, is being scrapped. How did this mistake come about?

  • CreatedMarch 27, 2015
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