ATI Teck manufactures an electronic component for a high-end computer. The company currently sells 50,000 units a year at a price of $180 per unit. These units are produced using a machine that was purchased five years ago at a cost of $1.2 million. It currently has a book value of $600,000; however, due to its specialized nature, it has a market value today of only $70,000. The machine, which is expected to last another five years, will have no salvage value. The costs to produce an electronic component are as follows:
Direct materials....................................................$15.00
Direct labour (4 hours 3 $30.00/hour)...........................120.00
Variable overhead (4 hours 3 $2.40/hour).........................9.60
Fixed overhead (4 hours 3 $3.20/hour)*.........................12.80
Total cost per unit................................................$157.40
* Based on an annual activity of 100,000 direct labour hours.
The company expects the following changes for next year:
• Theunitsellingpricewillincreaseby10%.
• Direct labour rates will increase by 15%.
• Sales are expected to increase to 52,000 units (within the capacity of present facilities) and remain at that level.
Management is currently considering the replacement of the company's old machine with a new one that would cost $2.5 million. The new machine is expected to last five years and to have a salvage value of $60,000 (straight-line depreciation is used). By using the new machine, management expects to cut variable direct labour hours to 3.5 hours per unit, but the company will have to hire an operator for the machine at $90,000 per year.
Instructions
(a) Determine whether or not the company should purchase the new machine.
(b) How many units would the company have to sell to earn annual profits of $460,000 (before taxes) if it were to purchase the new machine? Ignore any gain or loss on the sale of the old machine.