Baird Moran manages the cutting department of Greene Benson Company. He purchased a tree-cutting machine on January 1, Year 2, for $370,000. The machine had an estimated useful life of 5 years and zero salvage value, and the cost to operate it is $85,000 per year. Technological developments resulted in the development of a more advanced machine available for purchase on January 1, Year 3, that would allow a 20 percent reduction in operating costs. The new machine would cost $198,000 and have a 4-year useful life and zero salvage value. The current market value of the old machine on January 1, Year 3, is $210,000, and its book value is $296,000 on that date. Straight-line depreciation is used for both machines. The company expects to generate $240,000 of revenue per year from the use of either machine. Required a. Recommend whether to replace the old machine on January 1, Year 3. b. Prepare Income statements for four years (Year 3 through Year 6) assuming that the old machine is retained. c. Prepare Income statements for four years (Year 3 through Year 6) assuming that the old machine is replaced. Complete this question by entering your answers in the tabs below. X Answer is not complete. Required A Required B Recommend whether to replace the old machine on January 1, Year 3. Replace With New Required C Decision Keep Old 580,000 Total avoidable costs S Should the old machine be replaced on January 1, Year 3? < Required A S Yes 470.000✔ Required B >
Baird Moran manages the cutting department of Greene Benson Company. He purchased a tree-cutting machine on January 1, Year 2, for $370,000. The machine had an estimated useful life of 5 years and zero salvage value, and the cost to operate it is $85,000 per year. Technological developments resulted in the development of a more advanced machine available for purchase on January 1, Year 3, that would allow a 20 percent reduction in operating costs. The new machine would cost $198,000 and have a 4-year useful life and zero salvage value. The current market value of the old machine on January 1, Year 3, is $210,000, and its book value is $296,000 on that date. Straight-line depreciation is used for both machines. The company expects to generate $240,000 of revenue per year from the use of either machine. Required a. Recommend whether to replace the old machine on January 1, Year 3. b. Prepare Income statements for four years (Year 3 through Year 6) assuming that the old machine is retained. c. Prepare Income statements for four years (Year 3 through Year 6) assuming that the old machine is replaced. Complete this question by entering your answers in the tabs below. X Answer is not complete. Required A Required B Recommend whether to replace the old machine on January 1, Year 3. Replace With New Required C Decision Keep Old 580,000 Total avoidable costs S Should the old machine be replaced on January 1, Year 3? < Required A S Yes 470.000✔ Required B >
Chapter1: Financial Statements And Business Decisions
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Transcribed Image Text:**Case Study: Decision Making for Equipment Replacement**
Balrd Moran manages the cutting department of Greene Benson Company. He purchased a tree-cutting machine on January 1, Year 2, for $370,000. The machine had an estimated useful life of 5 years with zero salvage value, and the cost to operate it is $85,000 per year. Technological developments have led to a more advanced machine, available for purchase on January 1, Year 3, that allows a 20 percent reduction in operating costs. The new machine, priced at $198,000, has a 4-year useful life with zero salvage value. On January 1, Year 3, the current market value of the old machine is $210,000, and its book value is $296,000. Straight-line depreciation is applied to both machines. The company anticipates generating $240,000 of revenue per year from utilizing either machine.
**Required Analysis:**
a. Recommend whether to replace the old machine on January 1, Year 3.
b. Prepare income statements for four years (Year 3 through Year 6) assuming the old machine is retained.
c. Prepare income statements for four years (Year 3 through Year 6) assuming the old machine is replaced.
**Decision Matrix (Cost Comparison):**
| Decision | Total Avoidable Costs | Should the machine be replaced on January 1, Year 3? |
|----------------|-----------------------|-----------------------------------------------------|
| **Keep Old** | $580,000 | No |
| **Replace With New** | $470,000 | Yes |
Based on the total avoidable costs, it is recommended to replace the old machine on January 1, Year 3, as the cumulative cost over the equipment’s life would be lower with the new machine.
**Graph Explanation:**
The table illustrates a cost comparison between keeping the old machine and replacing it with the new one. The total avoidable costs are calculated, showing substantial savings with the new machine, supporting the recommendation for replacement.
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