Question

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?

Answer 1

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.