Question

# Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value...

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of \$43,000 and a remaining useful life of 5 years, at which time its salvage value will be zero. It has a current market value of \$53,000. Variable manufacturing costs are \$33,700 per year for this machine. Information on two alternative replacement machines follows.

 Alternative A Alternative B Cost \$ 116,000 \$ 114,000 Variable manufacturing costs per year 22,700 10,800

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?

Solution

Xinhong Company

Calculation of total change in net income if Alternative A is adopted:

 Alternative A - Cost to buy new machine (\$116,000) cash proceeds from old machine \$53,000 Savings in variable manufacturing costs \$55,000 (33,700 - 22,700) x 5 years Total change in net income (\$8,000)

Calculation of total change in net income if Alternative B is adopted:

 Alternative A - Cost to buy new machine (\$114,000) cash proceeds from old machine \$53,000 Savings in variable manufacturing costs \$114,500 (33,700 - 10,800) x 5 years Total change in net income \$53,500

The above two calculations indicate that the total change in net income for Alternative B is positive and higher compared to Alternative A. Hence, Xinhong should choose Alternative B - Replace the existing machine with Alternative B.

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