Prepare an incremental analysis for the 5 years showing whether Hancock should keep the existing machine or buy the new machine.
Hancock Company is trying to make a decision as to whether it should purchase of a new piece of equipment. The invoice price of the equipment is $140,000 with an estimate of $4,000 in freight charges and installation costs are expected to be $6,000. The Company expects that the salvage value of the new equipment will be zero after a useful life of 5 years.
If the new machine is not purchased, the Company’s existing equipment could be retained and used for an additional 5 years. At that time, the salvage value of the existing equipment would be zero. If the new machine is purchased now, the existing machine would have to be scrapped.
The following is data regarding annual sales and expenses with and without the new machine:
- Without the new machine, Hancock can sell 12,000 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.
- 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.
- Annual selling expenses are $180,000 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.
- Annual administrative expenses are expected to be $100,000 with the old machine, and $113,000 with the new machine.
- The current book value of the existing machine is $36,000. Aurora uses straight-line
depreciation.
Required: Prepare an incremental analysis for the 5 years showing whether Hancock should keep the existing machine or buy the new machine.
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