Chapter 5, Problem 5.5DMP

Judgment Case 6–5

Replacement decision

• LO6–3, LO6–7

Hughes Corporation is considering replacing a machine used in the manufacturing process with a new, more efficient model. The purchase price of the new machine is $150,000 and the old machine can be sold for $100,000. Output for the two machines is identical; they will both be used to produce the same amount of product for five years. However, the annual operating costs of the old machine are $18,000 compared to $10,000 for the new machine. Also, the new machine has a salvage value of $25,000, but the old machine will be worthless at the end of the five years.

Required:

Should the company sell the old machine and purchase the new model? Assume that an 8% rate properly reflects the time value of money in this situation and that all operating costs are paid at the end of the year. Ignore the effect of the decision on income taxes.