Question

Exercise 23-12 Keep or replace LO A1

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of $42,000 and a remaining useful life of 5 years, at which time its salvage value will be zero. It has a current market value of $52,000. Variable manufacturing costs are $33,100 per year for this machine. Information on two alternative replacement machines follows.

	Alternative A				Alternative B
Cost	$	117,000			$	116,000
Variable manufacturing costs per year		22,100				10,700

Calculate the total change in net income if Alternative A, B is adopted. Should Xinhong keep or replace its manufacturing machine? If the machine should be replaced, which alternative new machine should Xinhong purchase?

Calculate the total change in net income if Alternative A is adopted. (Cash outflows should be indicated by a minus sign.)

ALTERNATIVE A: INCREASE OR (DECREASE) IN NET INCOME
Cost to buy new machine
Cash received to trade in old machine
Reduction in variable manufacturing costs
Total change in net income

Calculate the total change in net income if Alternative B is adopted. (Cash outflows should be indicated by a minus sign.)

ALTERNATIVE B: INCREASE OR (DECREASE) IN NET INCOME
Cost to buy new machine
Cash received to trade in old machine
Reduction in variable manufacturing costs
Total change in net income

Should Xinhong keep or replace its manufacturing machine? If the machine should be replaced, which alternative new machine should Xinhong purchase?

Which option should Xinhong choose?

Answer 1

• All working forms part of the answer
• If asset is exchange currently it will be sold at book value = $52000
• Reduction in variable cost is considered for 5 years
• Both the alternatives are solved simultaneously side by side for understanding

	ALTERNATIVE A: INCREASE OR (DECREASE) IN NET INCOME	ALTERNATIVE B: INCREASE OR (DECREASE) IN NET INCOME
Cost to buy new machine [given]	$ -117,000	$ -116,000
Cash received to trade in old machine [given]	$52,000	$52,000
Reduction in variable manufacturing costs	$55,000 [(33100-22100) x 5 years]	$112,000 [(33100-10700) x 5 years]
Total change in net income	$ -10,000	$48,000

• Xinhong should Replace its manufacturing machine AND should Choose OPTION ‘B’ as it increases Net Income over 5 years by $48,000