Question

Differential Analysis for Machine Replacement Proposal

Flint Tooling Company is considering replacing a machine that has been used in its factory for four years. Relevant data associated with the operations of the old machine and the new machine, neither of which has any estimated residual value, are as follows:

Old Machine
Cost of machine, 10-year life	$107,800
Annual depreciation (straight-line)	10,780
Annual manufacturing costs, excluding depreciation	39,600
Annual nonmanufacturing operating expenses	12,700
Annual revenue	96,000
Current estimated selling price of the machine	35,000
New Machine
Cost of machine, six-year life	$136,800
Annual depreciation (straight-line)	22,800
Estimated annual manufacturing costs, exclusive of depreciation	18,800

Annual nonmanufacturing operating expenses and revenue are not expected to be affected by purchase of the new machine.

Required:

1. Prepare a differential analysis as of November 8 comparing operations using the present machine (Alternative 1) with operations using the new machine (Alternative 2). The analysis should indicate the total differential income that would result over the six-year period if the new machine is acquired. If an amount is zero, enter zero "0". Use a minus sign to indicate a loss.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
November 8
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues
Proceeds from sale of old machine
Costs
Purchase price
Annual manufacturing costs (6 yrs.)
Income (Loss)

Answer 1

Differential analysis

It would be beneficial to purchase the new machine, since it yields incremental profit of 23,000 over 6 years from a financial perspective. From a non financial perspective factors such as the production capacity per batch, quality of goods produced, probabilitites of breakdown, etc are to be considered.

Notes

1.The Annual revenue would be same no matter what machine is used (this might indicate that the quality and quantity of the product produced by the new machine is similar to what was produced by the old machine)

2.Annual non manufacturing operating expenses are same under both alternatives hence need not be considered for differential analysis

3.The purchase price of the old machine need not be considered for differential analysis since the same has been already incurred (i.e. sunk cost need not be considered for Differential analysis)

4.Proceeds from sale of old machine and the savings in annual manufacturing cost are benefits of buying the new machine and the price paid to purchase them is the cost associated to the decision