A machine produces 1000 units of product per day in an existing manufacturing operation. The machine has become obsolete due to tightened product quality standards. Replacement machine “A” will cost $15,000 and will produce the needed 1000 units of product per day for the next 3 years with annual escalated dollar operating costs projected to be $6,000 in year 1, $7,000 in year 2 and $8,000 in year 3 with a $2,000 escalated dollar salvage value at the end of year 3. Replacement machine "B" will cost $21,000 and can produce up to 1500 units of product per day for the next 3 years with annual escalated dollar operating costs of $5,000 in each of years 1, 2 and 3 for either 1000 or 1500 units per day, with a $3,000 escalated dollar salvage value at the end of year 3. Depreciate both machines using 5-year life MACRS depreciation starting in year 0 with the half-year convention. Assume that other taxable income exists that will permit using all tax deductions in the year incurred. For an effective income tax rate of 40%, use present worth cost analysis and break-even cost per unit of service analysis, assuming 250 working days per year, for a minimum escalated dollar DCFROR of 20% to determine if machine "A" or "B" is economically best assuming:
A) no use exists for the extra 500 units of product per day that machine "B" can produce.
B) another division of the company can utilize the extra 500 units of product capacity per day of machine "B" and that division will pick up one third of machine "B" capital cost, operating costs, depreciation, salvage value and related tax effects.
ANSWERS
Machine A: NPV = -$18,400 PW Annual Cost = $0.0582 /unit
Machine B: NPV = -$19,838 PW Annual Cost = $0.0628 /unit
Therefore choose A.
If the additional 500 units can be used: Machine B PW Annual Cost = $0.0419 /unit. Then choose Machine B.
REMEMBER:
Other income exists to use the depreciation against. USE MACRS 5 YEAR LIFE.
Use ALL remaining depreciation left (4&5) in year 3
Calculate the PW ANNUAL cost = +pmt(20%,3,PV)
THEN DIVIDE BY THE # UNITS PRODUCED - AFTER TAX /UNITS*(1-.40) to get the PW Annual cost per Unit.
That adjusts for the tax rate at 40%.
PLEASE WORK THROUGH EXCEL