Question

The TechAide Company produces and sells 6,000 modular computer desks per year at a selling price of $450 each. Its current production equipment, purchased for $1,350,000 and with a five-year useful life, is only two years old. It has a terminal disposal value of $0 and is depreciated on a straight-line basis. The equipment has a current disposal price of $550,000. However, the emergence of a new molding technology has led TechAide to consider either upgrading or replacing the production equipment. The following table presents data for the two alternatives: 

Answer 1

1) Should TechAide upgrade its production line or replace it? Show your calculations.
		For three years
	Upgrade	Replace	Difference
One-time equipment costs	$    30,00,000.00	$ 49,00,000.00	$  (19,00,000.00)
Variable manufacturing cost:( 6000 x 174 x 3 years); (6000 x $95 x 3 years)	$    31,32,000.00	$ 17,10,000.00	$    14,22,000.00
Current disposal price		$ (5,50,000.00)	$      5,50,000.00
Total relevant cost	$    61,32,000.00	$ 60,60,000.00	$         72,000.00
TechAide should replace the production line.
2) Now suppose the one-time equipment cots to replace the production equipment is somewhat negotiable. All other data are as given previously. What is the maximum one-time equipment cost that TechAide would be willing to pay to replace the old equipmentrather than upgrade it?
Let X = one-time equipment costs for replacing the equipment
X+ $1,710,000−$550,000 < $6,132,000
X = $1,710,000−$550,000 - $6,132,000	$    49,72,000.00
TechAide would prefer to replace, rather than upgrade, if the replacement cost of the new equipment does not exceed $4,972,000
3) Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but the production and sales quantity is not known. For what production and sales quantity would TechAide i) upgrade the equipment or ii) replace the equipment.
Let Y = production and sales quantity
i)Upgrade the equipment
$3,000,000+($174 x 3 xY)<$4,900,000+($95 x 3 x Y)−$550,000
$3,000,000+522Y<$4,350,000+285Y
Y =	5696	Units
ii)Replace the equipment
$3,000,000+($174 x 3 xY)<$4,900,000+($95 x 3 x Y)−$550,000
$3,000,000+522Y<$4,350,000+285Y
Y =	5696	units
4) Assume that all data are as given in the original exercise. Dan Doria is TechGAde’s manager, and his bonus is based on operating income.Because he is likely to relocate after about a year, his current bonus is his primary concern. Which alternative would Doria choose?
	Upgrade	Replace
Revenues  (6000 units x $450)	$    27,00,000.00	$ 27,00,000.00
Variable cost = (6000 units x $174) : (6000 x $95)	$    10,44,000.00	$   5,70,000.00
Depreciation ($810,000 + $3,000,000) ÷ 3; $4,900,000 ÷ 3	$    12,70,000.00	$ 16,33,333.33
Loss on disposal of old equipment (0; $810,000 – $550,000)	$                      -	$   2,60,000.00
Total Cost	$    23,14,000.00	$ 24,63,333.33
Operating Income	$      3,86,000.00	$   2,36,666.67
Book value of the current production equipment is $1,350,000 ÷ 5 × 3 =	$      8,10,000.00
First-year operating income is higher by $149,3333.33 ($386,000 – $236,666.67) under the upgrade alternative, and Dan Doria, with his one-year horizon and operating income-based bonus, will choose the upgrade alternative, even though, as seen in requirement 1, the replace alternative is better in the long run for TechAide