Question - Manger at X company purchases a cutting machine last year. 6 months after the purchase, he learned about a new cutting machine that is more reliable than the machine he purchased. The following info is available for the two machines:
Old machine
Acquisition Cost $300,000
Remaining Life 4 years
Salvage value now $100,000
Salvage value at end of 4 years $4,000
New Machine
Acquisition Cost $360,000
Remaining Life 4 years
Salvage value at end of 4 years $6,000
Annual operating costs for the old machine are $140,000. The new machine will decrease annual operating costs by $60,000. These amounts do not include any charges for depreciation. Company uses straight-line depreciation method. These estimates of operating costs exclude rework costs. The new machine will also result in a reduction in the defect rate from the current 5% to 2.5%. All defective units are reworked at a cost of $1 per unit. The company, on average produces 100,000 units annually.
a. Should manager replace old machine with new machine? Explain listing all relevant costs.
b. What costs should be considered as sunk costs for this decision?
c. What other factors may affect young's decision?