Aurora Company is considering the purchase of a new machine. The invoice price o

Question

Aurora Company is considering the purchase of a new machine. The invoice price of the machine is $115,000, freight charges are estimated to be $3,000, and installation costs are expected to be $5,000. Salvage value of the new equipment is expected to be zero after a useful life of 5 years. Existing equipment could be retained and used for an additional 5 years if the new machine is not purchased. At that time, the salvage value of the equipment would be zero. If the new machine is purchased now, the existing machine would have to be scrapped. Aurora’s accountant, Lisah Huang, has accumulated the following data regarding annual sales and expenses with and without the new machine.

With the class divided into groups, prepare an incremental analysis for the 5 years. (Ignore income tax effects.) (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Should Aurora keep the existing machine or buy the new machine?

1. Without the new machine, Aurora can sell 10,000 units of product annually at a per unit selling price of $100. If the new machine is purchased, the number of units produced and sold would increase by 10%, and the selling price would remain the same. 2. The new machine is faster than the old machine, and it is more efficient in its usage of materials. With the old machine the gross profit rate will be 25% of sales, whereas the rate will be 30% of sales with the new machine. 3. Annual selling expenses are $148,000 with the current equipment. Because the new equipment would produce a greater number of units to be sold, annual selling expenses are expected to increase by 10% if it is purchased. 4. Annual administrative expenses are expected to be $82,000 with the old machine, and $93,000 with the new machine. 5. The current book value of the existing machine is $30,000. Aurora uses straight-line depreciation.

Explanation / Answer

Aurora should buy the new machine.

Calculations:

Retain Old Machine Purchase New Machine Net Income Increase (Decrease) Sales $ 5000000 5500000 500000 Costs and expenses: Cost of goods sold 3750000 3850000 -100000 Selling expenses 740000 814000 -74000 Administrative expenses 410000 465000 -55000 Purchase price 0 123000 -123000 Total costs and expenses 4900000 5252000 -352000 Net income $ 100000 248000 148000

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