Question: CAPITAL BUDGETING

A Product is currently being manufactured on a machine that has a book value of $30000.The machine was originally purchased for $60000 ten years ago. The costs of the product are:

                                Unit Costs($)

Direct labour                    8.00

Direct Material                10.00

Variable O/H                    5.00

Fixed O/H                       5.00

TOTAL                          28.00

In the past year 6000 units were produced and sold for $50 per unit. It is expected that the old machine can be used for 10 years in the future.

An equipment manufacturer has offered to accept the old machine at $20000 in trade in for aa new version. The purchase price of the new machine is $ 100,000.The projected costs associated with the new machine are:

                                Unit Costs($)

Direct labour                   4.00

Direct Material                7.00

Variable O/H                   4.00

Fixed O/H                      7.00

TOTAL                          22.00

- The management also expects that, if the new machine is purchased,the net working capital requirement of the company would be less by $ 10000.

- The fixed overheads costs are allocations from other departments plus the depriciation of the equipment.

- The new machine has an expected life of 10 years with no salvage value;the straight line method of depriciation is employed by the company.

- It is expected that the future demand of the product would remain at 6000 units per year. Should the new equipment be acquired? Corporate tax rate is 55%