Kim Kwon Digital Components Company assembles circuit boards by using a manually operated machine to insert electronic components

Kim Kwon Digital Components Company assembles circuit boards by using a manually operated machine to insert electronic components. The original cost of the machine is $60,000, the accumulated depreciation is $24,000, its remaining useful life is five years, and its residual value is negligible. On May 4, 2014, a proposal was made to replace the present manufacturing procedure with a fully automatic machine that will cost $180,000. The automatic machine has an estimated useful life of five years and no significant residual value. For use in evaluating the proposal, the accountant accumulated the following annual data on present and proposed operations:


Present  
Operations
Proposed  
Operations
Sales$205,000 $205,000
Direct materials $ 72,000 $ 72,000
Direct labor51,000 —
Power and maintenance 5,000 18,000
Taxes, insurance, etc. 1,500 4,000
Selling and administrative expenses 45,000 45,000
Total expenses $174,500 $139,000


a. Prepare a differential analysis dated May 4, 2014, to determine whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2). Prepare the analysis over the useful life of the new machine.

b. Based only on the data presented, should the proposal be accepted?

c.  What are some of the other factors that should be considered before a final decision is made?


Answer:


a. Differential Analysis 
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) 
May 4, 2014 
 Continue 
with Old 
Machine 
(Alternative 1) 
Revenues:    
Sales (5 years)* $1,025,000 $1,025,000 $ 0 
Costs:    
Purchase price 0 –180,000 –180,000 
Direct materials (5 years)* –360,000 –360,000 0 
Direct labor (5 years)* –255,000 0 255,000 
Power and maintenance (5 years)* –25,000 –90,000 –65,000 
Taxes, insurance, etc. (5 years)* –7,500 –20,000 –12,500 
Selling and admin. expenses    
(5 years)* –225,000 –225,000 0 
Income (Loss) $   152,500 $   150,000 –$ 2,500 
    
* Each annual revenue and cost is multiplied by five years. 
b. The proposal should not be accepted. 
c. In addition to the factors given, consideration should be given to such factors 
as:  Do both present and proposed operations provide the same capacity? 
What opportunity costs are associated with alternative uses of the $180,000 
outlay required to purchase the automatic machine? Is the product improved 
by using automatic machinery? Does the federal income tax have an effect on 
the decision?