Xinhong Company is considering replacing one of its manufacturing machines. The

Question

Xinhong Company is considering replacing one of its manufacturing machines. The machine has a book value of $37,000 and a remaining useful life of 5 years, at which time its salvage value will be zero. It has a current market value of $47,000. Variable manufacturing Information on two alternative replacement machines follows costs are $33,500 per year for this machine Cost Variable manufacturing costs per year Alternative A $120,000 22,900 Alternative B $115,000 10,700 Calculate the total change in net income if Alternative A is adopted. (Cash outflows should be indicated by a minus sign.) ERNATIVE A: INCREASE OR (DECREASE) IN NET INCOME Cost to buy new machine Cash received to trade in old machine Reduction in variable manufacturing costs Total change in net income Calculate the total change in net income if Alternative B is adopted. (Cash outflows should be indicated by a minus sign.) LTERNATIVE B: INCREASE OR (DECREASE) IN NET INCOME Cost to buy new machine Cash received to trade in old machine Reduction in variable manufacturing costs Total change in net income

Explanation / Answer

Alternative A Cost to buy new machine -120000 Cash received to trade in old machine 47000 Net cost to buy new machine -73000 Less :Reduction in variable manufacturing costs ( 33500 - 22900) 10600 Total change in net income 10600 Alternative B Cost to buy new machine -115000 Cash received to trade in old machine 47000 Net cost to buy new machine -68000 Less :Reduction in variable manufacturing costs ( 33500 - 10700) 22800 Total change in net income 22800 Xinhong should replace the old machinery for the following reasons 1) The manufacturing cost of the new machine in both the alternatives is lower than the current machine 2) The machine is still fetching some market value , which will become 0 after 5 years of useful life If the ,achine is replaced , it should be replaced with alternative B because the net outflow of buying the machine is lower and also the positive change in the net income is higher in case of Alternative B

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