Question

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 $57,300, the accumulated depreciation is $22,900, 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 $119,200. 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	$181,600		$181,600
Direct materials	$61,900		$61,900
Direct labor	43,000		—
Power and maintenance	4,000		21,200
Taxes, insurance, etc.	1,400		4,800
Selling and administrative expenses	43,000		43,000
Total expenses	$153,300		$130,900

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".

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)
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? ( Should or shouldnt be accepted)

c. Differences in capacity between the two alternatives is _____ to consider before a final decision is made. ( Relevant or irrelevant )

Answer 1

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
4-May
	Continue with Old Machine	Replace Old Machine	Differential Effect on Income
	(Alternative 1)	(Alternative 2)	(Alternative 2)
Sales (5 years)	$   908,000.00	$ 908,000.00	$             0.00
Costs:
Purchase price	$             0.00	$ 119,200.00	$ (119,200.00)
Direct materials (5 years)	$   309,500.00	$ 309,500.00	$             0.00
Direct labor (5 years)	$   215,000.00	$            0.00	$ 215,000.00
Power and maintenance (5 years)	$     20,000.00	$ 106,000.00	$   (86,000.00)
Taxes, insurance, etc. (5 years)	$      7,000.00	$   24,000.00	$   (17,000.00)
Selling and admin. expenses (5 years)	$   215,000.00	$ 215,000.00	$            0.00
Income (Loss)	$   141,500.00	$ 134,300.00	$      7,200.00

Answer 2) The Proposal should be accepted because Differential effect on income is positive. In other words the additional benefit from replacement of old machine is positive that is why the proposal is financially beneficial and should be accepted.

Answer 3) Differences in capacity between the two alternatives is Relevant to consider before a final decision is made. If capacity of one alternative is more than the other then alternative having higher capacity will have high earning potential.