One of Eastvaco's business segments involves the manufacturing of laser printers. Each printer sells for $400. The profit margin on the printers have not met the expectations of the Company's CEO. He approaches the Plant Manager of the printer plant and asks for suggestions to improve the margin earned on printer sales. The Plant Manager explains to the CEO that increasing the sales price ($400) or sales quantity (50,000) is not possible in such a highly competitive market. Therefore, a reduction is cost may be the only possibility.
The Plant Manager is aware of a new piece of specialized equipment that should reduce the amount of labor required to produce the printers. The Plant Manager has come to you to prepare a schedule evaluating the two alternatives of keeping the old machine or purchase the new machine. To complicate matters, the plant manager receives a bonus on operating income, beginning next year. The following is data relating to the two machines.
- Existing Machine New Machine
- Original Cost $300,000 $135,000
- Useful life 5 years 3 years
- Current age 2 years 0 years
- Remaining useful life 3 years 3 years
- Accumulated depreciation $120,000 0
- Current book value $180,000 not purchased yet
- Current disposal value $95,000 not purchased yet
- Savage value in 3 years 0 0
- Annual cash operating costs $40,000 $10,000
- Annual revenues $1,000,000 $1,000,000
- Annual other operating costs $880,000 $880,000
Required:
Ignoring the time value of money should Eastvaco keep the old machine or purchase the new one? Review the concept of relevant cost. You will need to apply the concept of relevant cost to this problem..Prepare an income statement (combine three years into one combined income statement) showing which alternative would be best. Start the income statement with next year. Do not consider any costs this year since the plant manager is concerned about his bonus for the next three years.