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 $59,200, the accumulated depreciation is $23,700, 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 $123,100. 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	$187,700		$187,700
Direct materials	$63,900		$63,900
Direct labor	44,400		—
Power and maintenance	4,100		21,900
Taxes, insurance, etc.	1,500		4,900
Selling and administrative expenses	44,400		44,400
Total expenses	$158,300		$135,100

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". For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 4
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues:
Sales (5 years)	$	$	$
Costs:
Purchase price
Direct materials (5 years)
Direct labor (5 years)
Power and maintenance (5 years)
Taxes, insurance, etc. (5 years)
Selling and admin. expenses (5 years)
Income (Loss)	$	$	$

b. Based only on the data presented, should the proposal be accepted?

c. Differences in capacity between the two alternatives is   to consider before a final decision is made.

Answer 1

1.

Differential Analysis
Continue with Old Machine (Alt.1)or Replace Old Machine (Alt.2)
May-04
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential effects ( Alternative 2)
Revenues:
Sale ( 5 years)	938,500	938,500	0
Costs:
Purchase price	0	-123,100	-123,100
Direct materials ( 5 years)	-319,500	-319,500	0
Direct labor ( 5 years)	-222,000	0	222,000
Power and maintenance	-20,500	-109,500	-89,000
Taxes, insurance , etc ( 5 years)	-7,500	-24,500	-17,000
Selling and administrative expense ( 5 years)	-222,000	-222,000	0
Total expenses	-791,500	-675,500	116,000
Profit (Loss)	147,000	263,000	116,000

The old machine should be replaced.

Net incremental advantage of replacing old machine = $116,000