Question

The production department of Y Company is planning to purchase a new machine to improve product quality. The company’s management accountant is currently evaluating two options- Buy the machine OR Rent it. Following information is available:

1. The company has to pay £3,200 to set up the machine. Insurance cost £450 per annum.
2. If it is bought, the new machine is depreciated on reducing balance basis at the rate of 25%. After various calculations, the company has to pay £4,200 maintenance cost every year and estimated repair cost would be £300 per year. The firm will have to sell old machines, which had cost £65,000 six years ago. Apart from the above information, the £500 of delivery cost is incurred for this purchase option.
3. If it is rented, £ 4,650 per year to pay as rent. There is no cost for repair and maintenance. However, the firm is required to pay the administration charge of £650 with this rent option. For rent option, the delivery cost remains at 20% of the £ 500 (the delivery cost for purchase option). For the rent option, firm is not going to sell old machines.

Answer 1

SOLUTION

Due to absence of variours Information like

1) sale value of old machinery

2) purchase value of new machinery

3) finance cost of the company

so we assume company will finance new machinery totally from sale proceed of old machinery

and hence, we rely on running cost of the machinery per year to evaluate the both options

Running Cost Of machinery

Particulars	Buy Option	Rent Option
	Amount £	Amount £
Insurance	450	0
Maintenance	4200	0
Repairs	300	0
Administration Cost	0	650
Rent		4650
Annual Running Cost per year	4950	5300

As the running cost is low in Buy option company must buy the machinery

assumption

1) Insurance is payable by company in buy option only

2) Set up cost of £ 3200 is common in both options (one time cost )

3) Benefit of £400 in delivery expenses (one time expenses) in year one will not effect our decision as running cost per annum of rent option is £350 more than buy  option

so this benefit will not effect our decition