Question

Murl Plastics Inc. purchased a new machine one year ago at a cost of $42,000. Although the machine operates well, the president of Murl Plastics is wondering if the company should replace it with a new electronic machine that has just come on the market. The new machine would slash annual operating costs by two-thirds, as shown in the comparative data below:

  

	Present Machine			Proposed New Machine
Purchase cost new	$	42,000		$	63,000
Estimated useful life new		6	years		5	years
Annual operating costs	$	29,400		$	9,800
Annual straight-line depreciation		7,000			12,600
Remaining book value		35,000			—
Salvage value now		7,000			—
Salvage value in five years		0			0

  

In trying to decide whether to purchase the new machine, the president has prepared the following analysis:

  

Book value of the old machine	$	35,000
Less: Salvage value		7,000
Net loss from disposal	$	28,000

  

“Even though the new machine looks good,” said the president, “we can’t get rid of that old machine if it means taking a huge loss on it. We’ll have to use the old machine for at least a few more years.”

  

     Sales are expected to be $147,000 per year, and selling and administrative expenses are expected to be $88,200 per year, regardless of which machine is used.

  

Required:

1.	Prepare a summary income statement covering the next five years, assuming the following:

  

a.	The new machine is not purchased.
b.	The new machine is purchased.
	(Leave no cells blank - be certain to enter "0" wherever required.)

      

2.	Compute the net advantage of purchasing the new product using relevant costs.

  

     

Answer 1

(1) Income statement

	New machine is not purchased	New machine is purchased	Incremental revenue
Sales	147,000	147,000	0
Less: operating costs	- 29,400	- 9,800	19,600
Operating profit	117,600	137,200	19,600
Less: Depreciation	- 7,000	- 12,600	- 5,600
Less: Selling expenses	- 88,200	- 88,200	0
Net income	22,400	36,400	14,000

(2) If new machine is purchased, annaul income of the company will increase by $14,000 and this increase in income will accrue for the next 5 years.