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managerial accounting Assume that that Omani Company is considering the purchase of a newer, more efficient...
managerial accounting
Assume that that Omani Company is considering the purchase of a newer, more efficient yogurt-making machine. If purchased, it would require the new machine on January 2, year 1. Omani expects to sell 600,000 gallons of milk in each of the next five years at a $2 per gallon selling price.
Omani has two options:
(1) continue to operate the old machine purchased four years ago or
(2) sell it and purchase the new machine.
The following information has been prepared to help decide which option is more desirable.
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Omani is subject to a 40% income tax rate on all income. Assume the company uses the straight-line method for books and tax purposes. Assume that tax depreciation is calculated without regard to salvage value. Use an after-tax discount rate of 10%.
Solutions
Expert Solution
| Calculation Of Profit after tax from both the machines | ||||||
| Old Machine | New Machine | |||||
| Selling Price per Gallon | $ 2 | $ 2 | ||||
| variable Cost per gallon | $ 1 | $ 1 | ||||
| Contribution per gallon | $ 1 | $ 1 | ||||
| No. of gallons sold | $ 600,000 | $ 600,000 | ||||
| Total Contribution | $ 480,000 | $ 600,000 | ||||
| Less: Fixed Cash Cost | $ 400,000 | $ 160,000 | ||||
| Earnings before Depreciation | $ 80,000 | $ 440,000 | ||||
| Less:Depreciation | $ 228,571 | $ 400,000 | ||||
| Profit/(loss) before Tax | $ (148,571) | $ 40,000 | ||||
| Less: Tax@40% | $ - | $ 16,000 | ||||
| Profit after Tax | $ (148,571) | $ 24,000 | ||||
| Original Cost of acquisition of Machine | $ 1,600,000 | $ 2,000,000 | ||||
| Useful Life from date of acquisition(Years) | 7 | 5 | ||||
| Depreciation=Cost/useful Life | 1600000/7 | 2000000/5 | ||||
| $ 228,571.43 | $ 400,000.00 | |||||
| Calculation of present Value of Cash Flows from old machine | ||||||
| Year | Cash Flows | P.V@10% | Present Value of Cash Flows | |||
| 1 | $ 80,000 | 0.9091 | $ 72,727.27 | |||
| 2 | $ 80,000 | 0.8264 | $ 66,115.70 | |||
| 3 | $ 80,000 | 0.7513 | $ 60,105.18 | |||
| 3 | $ 200,000 | 0.7513 | $ 150,262.96 | |||
| $ 349,211.12 | ||||||
| Cash Flow fromOld Machine represents earnings before depreciation which accrued for 3 years | ||||||
| since machine is having useful life of 7 years out of which 4 years had already expired. | ||||||
| In the last year i.e, Year 3 machine has estimated Cash Value of $200000 which has been taken for calculation of Cash Inflows. | ||||||
| Cash Inflow if old machine is sold on Jan2,Year1 | $ 400,000.00 | |||||
| Present value of Cash Inflows if machine is used for production | $ 349,211.12 | |||||
| Loss if it is continued for production | $ 50,788.88 | |||||
| Calculation of present Value of Cash Flows from New machine | ||||||
| Year | Cash Flows | P.V@10% | Present Value of Cash Flows | |||
| 1 | $ 424,000 | 0.9091 | $ 385,454.55 | |||
| 2 | $ 424,000 | 0.8264 | $ 350,413.22 | |||
| 3 | $ 424,000 | 0.7513 | $ 318,557.48 | |||
| 4 | $ 424,000 | 0.6830 | $ 289,597.71 | |||
| 5 | $ 424,000 | 0.6209 | $ 263,270.64 | |||
| 5 | $ 500,000 | 0.6209 | $ 310,460.66 | |||
| $ 1,917,754.25 | ||||||
| Cash Flow from new machine represents Cash earned before depreciation less tax i.e $440000-$16000 | ||||||
| $424000 earned for 5 years .Cash Inflow from estimated value of machine at the end of 5th year | ||||||
| i.e,$500000 has been considered for calculation of cash inflows. | ||||||
| Present value of Cash outlow if machine is purchased | $ 2,000,000.00 | |||||
| Preesnt value of Cash InFlows when used for Production | $ 1,917,754.25 | |||||
| Loss | $ 82,245.75 | |||||
| Present Value of Loss if existing mahine is used for production is less than | ||||||
| Loss if new machine is purchased by $31456.87 i.e,$82245.75-$50788.88. | ||||||
| Hence continue to opearte old machine purchased 4 years ago. | ||||||
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