Replacement Decision

1. The new machine tool is simply beautiful, exclaimed John Ogletree, industrial engineer for Trent Manufacturing Company. No wonder the plant manager is so anxious to buy it. I am not sure it is worth replacing the present machine tool, replied Jerry Hanson, operation manager. Everyone seems to forget that we purchased our present machine just four years ago at a cost of $12,000. The new tool will cost $15,000. The worst part is that we can only get $2,000 out of old machine tool if we sell it now. Thats quite a loss for the company to absorb. We can make up the loss very quickly, countered John. Willow Creek Manufacturing Co. in the northern part of the state says that scrap loss decreased by 20% when they purchased these new tools. Ive gathered a lot of information about the new tools, and I will have a recommendation ready for the plant manager tomorrow. Option 1: You continue to use an old machine tool that was bought 4 years ago for $12,000. It has been fully depreciated but can be sold for $2,000. If kept, it could be used for 3 more years with proper maintenance and with some extra care. No salvage value is expected at the end of 3 years. The maintenance costs would run $10,000 per year for the old machine tool. Option 2: You purchase a brand-new machine tool at a price of $15,000 to replace the present equipment. Because of the nature of the product manufactured, it also has an expected economic life of 3 years, and will have a salvage value of $5,000 at the end of that time. With the new machine tool, the expected operating and maintenance costs (with the scrap savings) amount to $3,000 each year for 3 years. The allowed depreciation amounts for the new machine are $5,000 during the first year, $6,668 during the second year, and $1,110 (with the half-year convention) during the third year.

The income tax rate is 35%. Any gains will also be taxed at 35%.

1. machine now in use, which was bought 5 years ago for $4,000, has been fully depreciated. It can be sold for $2,500, but could be used for 3 more years (remaining useful life), at the end of which time it would have no salvage value. The annual operating and maintenance costs for the old machine amount to $10,000. A new machine can be purchased at an invoice price of $14,000 to replace the present equipment. Because of the nature of the manufactured product, the new machine has an expected economic life of 3 years, and it will have no salvage value at the end of that time. The new machines expected operating and maintenance costs amount to $2,000 for the first year and $3,000 for each of the next 2 years. The income tax rate is 34%. Any gains will also be taxed at 34%. The allowed depreciation amounts for the new machine are $1,400 during the first year, and $2,800 per year for the next 2 years. The firms interest rate is 15%.