Shiny Car Wash has just today paid for and installed a special machine for polishing cars at one of its several outlets. It is the first day of the company’s fiscal year. The machine costs $ 40,000, and its annual cash operating costs total $ 30,000. The machine will have a 4- year useful life and a zero terminal disposal value.

After the Shiny Car Wash uses the machine for only one day, a salesperson offers a different machine that promises to do the same job at annual cash operating costs of $ 18,000. The new machine will cost $ 48,000 cash, installed. The “old” machine is unique and can be sold outright for only $ 20,000, minus $ 4,000 removal cost. The new machine, like the old one, will have a 4- year useful life and zero terminal disposal value.

Revenues, all in cash, will be $ 300,000 annually, and other cash costs will be $ 220,000 annually, regard-less of this decision.

For simplicity, ignore income taxes and the time value of money.

Required

1. a. Prepare a statement of cash receipts and disbursements for each of the 4 years under each alternative. What is the cumulative difference in cash flow for the 4 years taken together?

b. Prepare income statements for each of the 4 years under each alternative. Assume straight- line depreciation. What is the cumulative difference in operating income for the 4 years taken together?

c. What are the irrelevant items in your presentations in requirements a and b? Why are the items irrelevant?

2. Suppose the cost of the “old” machine was $ 1 million rather than $ 40,000. Nevertheless, the old machine can be sold outright for only $ 20,000, minus $ 4,000 removal cost. Would the net differences in require-ments 1a and 1b change? Explain.

3. Is there any conflict between the decision model and the incentives of the manager who has just purchased the “ old” machine and is considering replacing it a day later?