Sugar Sweet (SS) Company produces and sells 7,000 specialty Treats per year at a selling price of

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Question:

Sugar Sweet (SS) Company produces and sells 7,000 specialty Treats per year at a selling price of $850 each. Its current production equipment, purchased for $1,850,000 and with a five-year useful life, is only two years old. It has a terminal disposal value of $0 and is depreciated on a straight-line basis. The equipment has a current disposal price of $500,000. However, the emergence of a new technology has led SS to consider either upgrading or replacing the production equipment. The following table presents data for the two alternatives: A B C 1 Choice Upgrade Replace 2 One-time equipment costs $3,000,000 $4,800,000 3 Variable manufacturing cost per Treat $150 $70 4 Remaining useful life of equipment (years) 3 3 5 Terminal disposal value of equipment 0 0

Required

1. Should SS upgrade its production line or replace it? Show your calculations.

2. Suppose the one-time equipment cost to replace the production equipment is negotiable. All other data are as given previously. What is the maximum one-time equipment cost that SS would be willing to pay to replace the old equipment rather than upgrade it? (10 Marks)

3. Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but that the production and sales quantity is not known. For what production and sales quantity would SS:

(i) upgrade the equipment or (ii) replace the equipment?

4. Assume that all data are as given in the original exercise. Nick Son is SS’s manager, and his bonus is based on operating income. Because he is likely to relocate after about a year, his current bonus is his primary concern. Which alternative would Nick Son choose? Explain.