Question

Differential Analysis for Machine Replacement

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 $87,000, the accumulated depreciation is $34,800, its remaining useful life is five years, and its residual value is negligible. On May 4 of the current year, a proposal was made to replace the present manufacturing procedure with a fully automatic machine that has a purchase price of $181,000. 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	$275,800		$275,800
Direct materials	$94,000		$94,000
Direct labor	65,300		—
Power and maintenance	6,100		32,200
Taxes, insurance, etc.	2,200		7,200
Selling and administrative expenses	65,300		65,300
Total expenses	$232,900		$198,700

a. Prepare a differential analysis dated May 4, 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. If an amount is zero, enter "0".

Answer 1

The data given are for one year we will find proposed and present projects data for five years

Differential analysis

	Continue with old machine	Replace oldmachine	Differential effect
Revenue:
Sales (5 years)	$1,379,000($275,800*5)	$1,379,000($275,800*5)	$0
Cost:
Purchase price	$0	-$181,000	-$181,000
Direct Material	-$470,000($94,000*5)	-$470,000($94,000*5)	$0
Direct Labor	-$326,500($65,300*5)	$0	$326,500
Power and maintenance	-$30,500($6,100*5)	-$161,000($32,200*5)	-$130,500 [$30,500-$161,000]
TaxesInsurance etc	-$11,000(2,200*5)	-$36,000(7,200*5)	-$25,000($11,000-$36,000)
selling and administrative	-$326,500($65,300*5)	-$326,500($65,300*5)	$0
income(Loss)	$214,500	$204,500	-$10,000

cost of old machine is a sunk cost and hence not relevant here as it has already been incurred.

machien should not be replaced as it will reduce income by $10,000