Question

Expand Your Critical Thinking 7-1

Aurora Company is considering the purchase of a new machine. The invoice price of the machine is $115,000, freight charges are estimated to be $3,000, and installation costs are expected to be $5,000. Salvage value of the new equipment is expected to be zero after a useful life of 5 years. Existing equipment could be retained and used for an additional 5 years if the new machine is not purchased. At that time, the salvage value of the equipment would be zero. If the new machine is purchased now, the existing machine would have to be scrapped. Aurora’s accountant, Lisah Huang, has accumulated the following data regarding annual sales and expenses with and without the new machine.

1.		Without the new machine, Aurora can sell 10,000 units of product annually at a per unit selling price of $100. If the new machine is purchased, the number of units produced and sold would increase by 10%, and the selling price would remain the same.
2.		The new machine is faster than the old machine, and it is more efficient in its usage of materials. With the old machine the gross profit rate will be 25% of sales, whereas the rate will be 30% of sales with the new machine.
3.		Annual selling expenses are $148,000 with the current equipment. Because the new equipment would produce a greater number of units to be sold, annual selling expenses are expected to increase by 10% if it is purchased.
4.		Annual administrative expenses are expected to be $82,000 with the old machine, and $93,000 with the new machine.
5.		The current book value of the existing machine is $30,000. Aurora uses straight-line depreciation.

Prepare an incremental analysis for the 5 years. (Ignore income tax effects.) (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

				Retain Old Machine		Purchase New Machine		Net Income Increase (Decrease)
Sales				$		$		$
Costs and expenses
	Cost of goods sold
	Selling expenses
	Administrative expenses
	Purchase price
		Total costs and expenses
Net income				$		$		$

Should Aurora keep the existing machine or buy the new machine?

Aurora should keep the existing machinebuy the new machine .

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Answer 1

There is an Incremental Income of $ 148,000.

Therfore comapany should buy the machine

Workings

	Retain Old Machine	With New Machine	Variance
Units	10000	11000	1000
Selling Price	$              100	$                 100	$                       -
Sales (A)	$ 10,00,000	$     11,00,000	$          1,00,000
Gross profit %	25%	30%	5%
Gross profit	$     2,50,000	$       3,30,000	$              80,000
Cost and expenses:
Cost of good sold ( Sale-Gross Profit )	$     7,50,000	$       7,70,000	$              20,000
Selling expense	$     1,48,000	$       1,62,800	$              14,800
Annual Admn Expenses	$        82,000	$           93,000	$              11,000
Total (B)	$     9,80,000	$     10,25,800	$              45,800
Annual Income (A-B)	$        20,000	$           74,200	$              54,200
Total Income of 5 years	$     1,00,000	$       3,71,000	$          2,71,000
Less: Cost of New Asset		$       1,23,000	$          1,23,000
Net Income	$     1,00,000	$       2,48,000	$          1,48,000

Cost of New Asset= $ 115,000 + $ 3,000 + $ 5,000