New $300,000 machine is expected to have 5-year life and terminal value of $0. It can make 40,000 units a year at the variable cost of $4 per unit. Variable cost is $6.50 per unit with the old machine, which also has the capacity of 40,000 units a year and book value of $100,000. It is being depreciated on the straight line basis at $20,000 per year. It too is expected to have the terminal value of $0. Its present disposal value is also $0 as it is highly specialized equipment.
Salesperson of new machine made the following comparisons: -
new machine$ old machine$
Units 40,000 40,000
Variable costs 160,000 260,000
Straight line depreciation 60,000 20,000
Total cost 220,000 280,000
Unit cost 5.50 7.00
He said, new machine is clearly a valuable acquisition. You will save $1.50 for every unit you make.
(a) Do you have the same opinion with salesperson's analysis? If not, how would you modify it? Be precise and ignore taxes. Would you recommend keeping old machine or replacing it with new one?
(b) Make the analysis of total and unit differential costs if annual volume is 20,000 units.
(c) At what annual volume would both old and new machines have same total applicable costs?