On January 2, 2015, the S. H. Park Company (Park) installed a new $84,000 special molding machine for producing a new product. The product and the machine have an expected life of three years. The machines expected disposal value (amount machine can be sold for) at the end of three years is zero. S. H. Park Company paid cash when the equipment was delivered.  Park paid for this machinery via bank transfer.

On January 3, 2015, Kimiyo Lee, a salesperson for BT Machine and Tool (BT), tells Park: “I wish I had known earlier of your purchase plans.  I can supply you with a technically superior machine for $99,000.

Lee indicated the machine just purchased can be sold for $16,000.  Lee guaranteed that there machine will save S. H. Park $35,000 per year in cash operating costs.  This machine will have no disposal value at the end of three years.”  Assume all costs are cost of sales. 

Park examines some technical data.  Park is confident of Lee’s claims.  However, Park contends, “I’m locked in now.  My alternatives are clear: (a) disposal will result in a loss, (b) keeping and using the ‘old’ equipment avoids such a loss.  I have brains enough to avoid a loss when my other alternative is recognizing a loss. We’ve got to use that equipment until we get our money out of it.”

The annual operating costs of the old machine are $60,000 all paid in cash.  This does not include depreciation.  The new machine operating costs will be $25,000 which will be paid in cash.  Sales, all in cash, are projected to be $850,000 per year.  Annual cash expenses related to sales are $350,000 for material, $250,000 for labor and $150,000 for other operating expenses regardless of this decision.  Assume that the equipment in question is the company’s only fixed asset.

Ignore income taxes and the time value of money.  Any cash payments for the machines occurred in 2015 coinciding with the purchase of the equipment.

Should Park dispose of the “old-old” machine (stay the course) or should Park acquire new machine’s (New-New) from Lee?

Prepare income statements as they would appear in each of the next three years under both alternatives. Assume straight-line depreciation over a three year period. What is the cumulative increase or decrease in net income for the three years for each alternative?

Prepare statements of cash receipts and disbursements as they would appear in each of the next three years under both alternatives. Assume straight-line depreciation over a three year period.  What is the total cumulative increase or decrease in cash for the three years for each alternative?