Question

The production department of X Company is planning to purchase a new machine to improve product quality. The company’s management accountant is currently evaluating two options- Buy the machine OR Rent it. Following information is available:

1. The company has to pay £3,200 to set up the machine. Insurance cost £450 per annum.  
2. If it is bought, the new machine is depreciated on reducing balance basis at the rate of 25%. After various calculations, the company has to pay £4,200 maintenance cost every year and estimated repair cost would be £300 per year. The firm will have to sell old machines, which had cost £65,000 six years ago. Apart from the above information, the £500 of delivery cost is incurred for this purchase option.
3. If it is rented, £ 4,650 per year to pay as rent. There is no cost for repair and maintenance. However, the firm is required to pay the administration charge of £650 with this rent option. For rent option, the delivery cost remains at 20% of the £ 500 (the delivery cost for purchase option). For the rent option, firm is not going to sell old machines.

Should the company buy or rent new machine?

Answer 1

If company decides to buy the machine then the yearly cost would be $4500 (4200+300)

and intial cost would be $4150(3200+450+500)

For this option the company will sell the old machine @11568 (assuming that old machine will be sold at WDV)

If company decides to rent it then yearly cost would be $5300(4650+650)

AND intial cost would be $100

As production department is planning to purchase new machinery to improve the quality of product so old machine would have become idle /obsolete and will provide lesser amount due to depreciation. It is better to sell the old machine and buy the new one.

As this will save yearly cost that would have been more if the renting option is choosen.