King Company makes a single product that it sells to retail stores. The firm's finishing department uses hand labor to perform its work on all products. A proposal has been made by the company's vice president to acquire machinery that will perform most of the functions of this department. The finishing department has consistently produced 50,000 units a year, and that is the estimated production for the foreseeable future. A summary of the manufacturing costs of the department follows:
Direct materials ........................................ $125,000
Direct labor ............................................. 937,500
Manufacturing overhead:
Variable costs .......................................... 187,500
Fixed costs ............................................. 125,000
The machinery being considered will cost $960,000 and have an estimated useful life of six years, with no salvage value. The machinery will cause the following changes in costs:
a. Direct labor will decrease by $9 per unit.
b. Direct materials will not change.
c. Variable manufacturing overhead will decrease by $1.75 per unit.
d. Fixed manufacturing overhead will increase by $50,000 per year.
INSTRUCTIONS
1. Prepare an analysis showing the effect on net income of purchasing the equipment.
2. What other factors should be considered in making the decision?
Analyze: Assume that the use of the new machinery will increase the number of imperfect products produced by 2 percent of total production. These imperfect products must be reprocessed at a cost of $10 per unit, increasing variable manufacturing costs. What net annual increase or decrease in costs can be projected?