Sean Fitzpatrick manages the Peoria plant of Garcia Manufacturing. A representat

Question

Sean Fitzpatrick manages the Peoria plant of Garcia Manufacturing. A representative of Darien Engineering approaches Fitzpatrick about replacing a large piece of manufacturing equipment that farcia uses in its process with a more efficient model. While the representative made some compelling arguments in favor of replacing the 3 year old equipment, Fitzpatrick is hesitant. Fitzpatrick is hoping to be promoted next year to manager of the larger Detroit plant, and he knows that the accrual basis net operating income of the Peoria plant will be evaluated closely as part of the promotion decision. the following information is available concerning the equipment replacement decision: The historic cost of the old machine is $600,000. It has a current book value of $240,000, two remaining years of useful life, and market value of $144,000. annual depreciation expense is $120,000. it is expected to have a salvage value of $0 at the end of its useful life. The new equipment will cost $360,000. it will have a 2-year useful life and a $0 salvage value. Garcia use straight line depreciation on all equipment. The new equipment will reduce electricity costs by $70,000 per year and will reduce direct manufacturing labor costs by $60,000 per year. 1. Assume that Fitzpatrick's priority is to receive the promotion and he makes the equipment replacement decisions based on next year's accrual-based net operating income. Which alternative would he chose? Show calculations. 2. What are the relevant factors in the decision? Which alternative is in the best interest of the company over the next 2 years? Show your calculations. 3. At what cost would Fitzpatrick be willing to purchase the new equipment? Explain.

Explanation / Answer

First year results Replace Keep Cost Difference by Replacing 1 Cash Operating Expenses 2 Eelectricity Cost -$70000 $0 -$70000 3 Direct Manufacturing Labour Cost -$60000 $0 -$60000 4 Depreciation $180000 $120000 $60000 5 Loss on sale of Old Machine(240000-144000) $96000 $0 $96000 6 Total Operating Costs $146000 $120000 $26000 The Two year period based decision model should be consistant but Fitzpatrick's focus is on first year results The Extra cost of $26000 in the First year suggest that he has to leave the decision to replace the machine Unless his Promotion may affect by his decision

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