Westwood Furniture Company is considering the purchase of two different items of equipment, as described below: Machine

Question:

Westwood Furniture Company is considering the purchase of two different items of equipment, as described below:

Machine A

A compacting machine has just come onto the market that would permit Westwood Furniture Company to compress sawdust into various shelving products. At present the sawdust is disposed of as a waste product. The following information is available on the machine:

(a) The machine would cost $420,000 and would have a 10% salvage value at the end of its 12-year useful life. The company uses straight-line depreciation and considers salvage value in computing depreciation deductions.

(b) The shelving products manufactured from use of the machine would generate revenues of $300,000 per year. Variable manufacturing costs would be 20% of sales.

(c) Fixed expenses associated with the new shelving products would be (per year): advertising, $40,000: salaries, $110,000; utilities, $5,200; and insurance, $800.

Machine B

A second machine has come onto the market that would allow Westwood Furniture Company to automate a sanding process that is now done largely by hand. The following information is available:

(a) The new sanding machine would cost $234,000 and would have no salvage value at the end of its 13-year useful life. The company would use straight-line depreciation on the new machine.

(b) Several old pieces of sanding equipment that are fully depreciated would be disposed of at a scrap value of $9,000.

(c) The new sanding machine would provide substantial annual savings in cash operating costs. It would require an operator at an annual salary of $16,350 and $5,400 in annual maintenance costs. The current hand-operated sanding procedure costs the company $78,000 per year in total.

Westwood Furniture Company requires a simple rate of return of 15% on all equipment purchases. Also, the company will not purchase equipment unless the equipment has a payback period of 4.0 years or less.

Required:

1. For machine A:

(a) Prepare a contribution format income statement showing the expected net operating income each year from the new shelving products.

(b) Compute the simple rate of return.

2. For machine B:

(a) Compute the simple rate of return.

(b) Compute the payback period.

3. According to the company’s criteria, which machine, if either, should the company purchase?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...