The company are considering selling their old machine that has a capital cost of £260 000 and replacing it with an up-to-date model costing £220 000. For immediate purchase the company will receive £120 000-part exchange allowance. Both the current and new machines are able to meet the expected company demand, estimated at: Year Units 1 90 000 2 50 000 3 30 000 After three years, it is predicted that demand will be zero due to the technological developments in the industry. The following data has been provided for the existing and new machine: Current Machine £ per unit New Machine £ per unit Direct Materials 1.80 1.80 Direct Labour 0.75 0.60 Variable Overheads 0.45 0.30 Depreciation 0.35 0.55 Additional information The selling price for each component is £5.00 and this will remain constant for the next three years. The company expect the cost of direct materials and direct labour to increase by 5% each year. The company predicts that repair and maintenance costs for the current machine will be £7000 per annum. The current machine is expected to have a zero-residual value at the end of year 3. The company predicts that repair and maintenance costs for the new machine will be £1000 per annum. The new machine is expected to have a £75 000 residual value at the end of year 3. The company’s cost of capital is 15% Extract from the present value table for £1 at 15% Year Units 1 0.870 2 0.756 3 0.658 4 0.572 Pietro would like you to produce a business report that can be given to the company offering advice on the best course of action for the purchase / replacement machine. REQUIRED Prepare a report that evaluates the capital expenditure proposals using appropriate financial techniques.

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 15E: Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided...

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Question

The company are considering selling their old machine that has a capital cost of £260 000 and replacing it with an up-to-date model costing £220 000. For immediate purchase the company will receive £120 000-part exchange allowance.

Both the current and new machines are able to meet the expected company demand, estimated at:

Year	Units
1	90 000
2	50 000
3	30 000

After three years, it is predicted that demand will be zero due to the technological developments in the industry.

The following data has been provided for the existing and new machine:

	Current Machine £ per unit	New Machine £ per unit
Direct Materials	1.80	1.80
Direct Labour	0.75	0.60
Variable Overheads	0.45	0.30
Depreciation	0.35	0.55

Additional information

The selling price for each component is £5.00 and this will remain constant for the next three years.
The company expect the cost of direct materials and direct labour to increase by 5% each year.
The company predicts that repair and maintenance costs for the current machine will be £7000 per annum.
The current machine is expected to have a zero-residual value at the end of year 3.
The company predicts that repair and maintenance costs for the new machine will be £1000 per annum.
The new machine is expected to have a £75 000 residual value at the end of year 3.

The company’s cost of capital is 15%

Extract from the present value table for £1 at 15%

Year	Units
1	0.870
2	0.756
3	0.658
4	0.572

Pietro would like you to produce a business report that can be given to the company offering advice on the best course of action for the purchase / replacement machine.

REQUIRED

Prepare a report that evaluates the capital expenditure proposals using appropriate financial techniques.

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