Question

In a business setting, we are often asked to write a memo to communicate with internal and external professionals. To further advance your learning of memo communication, this written case requests that you prepare a memo to communicate within the company.

Background:

As the senior accountant at Technology on Demand (TOD), which manufactures mobile technology such as flip phones, smartphones, notebooks, and smartwatches, you are often asked to prepare various financial analysis necessary for decision making. Michelle Dodd, the controller, asked you to evaluate whether a piece of factory equipment should be replaced or kept. The old piece of factory equipment was purchased four years ago for $875,000. Over the last four years, TOD has allocated depreciation based on the straight-line method. The expected salvage value is $25,000. The current book value of the factory equipment is $425,000. The operating expenses total approximately $45,000 a year. It is estimated that the residual value (market value) of the old machine is $350,000. The controller is contemplating whether to replace the piece of factory equipment. The replacement factory equipment would consist of a purchase price of $500,000, a useful life of eight years, salvage value of 30,000, and annual operating costs of $35,000. In consideration of the background, prepare a memo in a Word document to submit to the controller. Your first paragraph would be an introduction paragraph of what the memo is about. Next, you will want to consider the equipment replacement decision. To add clarity to your discussion, you are to insert a table comparing the old equipment to the new equipment. In evaluating the “relevant” costs, what does your analysis show? Do you recommend that the equipment be replaced or kept ongoing for the next eight years? Why or why not?

Answer 1

MEMORANDUM

DATE:

TO: Michelle Dodd, Controller

FROM: Senior Accountant

SUBJECT: Evaluation of the replacement of old equipment

There has been ongoing contemplation within the organisation regarding evaluation of the proposal that whether the old piece of factory equipment be replaced with a new one.

Based on our evaluation we have concluded that the old equipment be replaced by the new piece of equipment which will result in annual cost savings of $51,250. Since the entity will have to finance the purchase of new equipment with its own funds of $150,000 in addition to the proceeds from sale of old equipment this will result in net savings of $60,000 at the end of four years from now.

Following tabular comparison forms the basis of our conclusion:

Particulars	Old Equipment	New Equipment
Current book value	425000
Expected market value	350000
Purchase price of new equipment		500000
Additional expenditure in purchase		150000	(X)
of new equipment
Analysis of Costs Associated
Annual Depreciation	100000	58750
Operating Expenses	45000	35000
	145000	93750
Salvage Value	25000	30000
Cost to be incurred in next four years	580000	375000
Savings in cost		205000	(Y)
Additional Salvage value		5000	(Z)
Net Savings (Y+Z-X)		60000