Question

Differential Analysis Report 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	$109,500
Annual depreciation (straight-line)	10,950
Annual manufacturing costs, excluding depreciation	38,700
Annual nonmanufacturing operating expenses	11,700
Annual revenue	94,100
Current estimated selling price of the machine	35,200
New Machine
Cost of machine, six-year life	$136,200
Annual depreciation (straight-line)	22,700
Estimated annual manufacturing costs, exclusive of depreciation	17,500
Annual nonmanufacturing operation expenses	10,000

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

Required:

1. Prepare a differential analysis report comparing operations utilizing the new machine with operations using the old machine. The analysis should indicate the differential income that would result over the six-year period if the new machine is acquired. Enter all amounts as positive numbers.

Flint Tooling Company
Proposal to Replace Machine
	$
	$
Number of years applicable	x
	$
	$
	$

2. What are some of the other factors that should be considered before a final decision is made?

1. Are there any improvements in the quality of work turned out by the new machine?
2. What other opportunities are available for the use of the funds that are required to purchase the new machine?
3. What effect does the federal income tax have on the decision?
4. What is the book value of the machine that will be replaced?

Select the relevant factor(s) from the list above.

Answer 1

Flint Tooling Company
Proposal to Replace Machine
	Old m/c	New m/c	Differential
Annual revenue	94100	94100	0	Income remains same
Expenses:
Annual manufacturing costs, excluding depreciation	38700	17500	-21200	Expense reduced	F
Annual nonmanufacturing operating expenses	11700	10000	-1700	Expense reduced	F
Total expenses (excl.depn.)	50400	27500	-22900	Expense reduced	F

Other cash flows
Initial year	35200	-136200		Outflow increases
Depn. Tax rate for	10950	22700	DTS=11750*Tax rate	Inflow increases

From the above analysis , it can be seen that there is a savings of $ 22900 in annual expenses, thereby increasing before-tax annual income by that much .

In addition ,there is incremental tax savings of $ 11750*Tax rate , if the new machine is installed.

Flint Tooling Company
Proposal to Replace Machine
Reduction in annual mfg. costs (excl.depn.)	21200
Reduction in non- mfg. opg. Exp.	1700
Total reduction in expenses	22900
Number of years applicable	6
Total reduction in expenses	137400

2…

1.Improvements in quality of work--Manufacturing & operating costs are reduced , indicating better quality of work.

2.Opportunities available for use of money are aplenty . But that is not a relevant factor to consider before making this decision of whether to continue with the old m/c or buy a new one. It is only the cash flows that are relevant to both m/cs that should be considered & not the money itself.

3.Yes. The effect of federal income tax will be felt differently , in regard to the 2 m/cs--as far as depreciation is concerned--- that is cash outflow saved depends on the annual depreciation amount ,that is different for the 2 m/cs.---as the tax rate is the same for all expenses, it will not have any direct impact on the decision---but only thro'the quantum of expenses.

4. Book value of the old m/c will have its effect felt on the replacement decision--in as much as--arriving at the capital gain/loss on sale of the m/c ---on which tax to be paid/ saved , is calculated ---& the net amt.,ie. Salvage-tax = the after-tax cash flow on sale of the m/c---that reduces the impact of intial investment in the new m/c.

So, the answer will be 1, 3 & 4