Sell or process-further decision:
The purpose of sell or process-further decision is to choose an appropriate alternative that maximizes the operating income. It uses incremental analysis which determines the incremental revenue.
Incremental revenue refers to the difference in the total revenue earned when the product or service is sold at split-off point and the total revenue earned when the product or service is sold after further processing.
If the incremental revenue is more than the incremental costs, the product should be sold after further processing. If the incremental revenue is lesser than the incremental costs, the product should be sold at split-off point.
To prepare: An analysis to show whether the old machine must be retained or replaced.
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- Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 25%. Should Chen buy the new machine?arrow_forwardFriedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.arrow_forwardNewmarge Products Inc. is evaluating a new design for one of its manufacturing processes. The new design will eliminate the production of a toxic solid residue. The initial cost of the system is estimated at 860,000 and includes computerized equipment, software, and installation. There is no expected salvage value. The new system has a useful life of 8 years and is projected to produce cash operating savings of 225,000 per year over the old system (reducing labor costs and costs of processing and disposing of toxic waste). The cost of capital is 16%. Required: 1. Compute the NPV of the new system. 2. One year after implementation, the internal audit staff noted the following about the new system: (1) the cost of acquiring the system was 60,000 more than expected due to higher installation costs, and (2) the annual cost savings were 20,000 less than expected because more labor cost was needed than anticipated. Using the changes in expected costs and benefits, compute the NPV as if this information had been available one year ago. Did the company make the right decision? 3. CONCEPTUAL CONNECTION Upon reporting the results mentioned in the postaudit, the marketing manager responded in a memo to the internal audit department indicating that cash inflows also had increased by a net of 60,000 per year because of increased purchases by environmentally sensitive customers. Describe the effect that this has on the analysis in Requirement 2. 4. CONCEPTUAL CONNECTION Why is a postaudit beneficial to a firm?arrow_forward
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- Oriole Company has a factory machine with a book value of $88,900 and a remaining useful life of 7 years. It can be sold for $31,600. A new machine is available at a cost of $484,500. This machine will have a 7-year useful life with no salvage value. The new machine will lower annual variable manufacturing costs from $613,200 to $508,100. Prepare an analysis showing whether the old machine should be retained or replaced. (In the first two columns, enter costs and expenses as positive amounts, and any amounts received as negative amounts. In the third column, enter net income increases as positive amounts and decreases as negative amounts. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Variable manufacturing costs New machine cost Sell old machine Total Retain Equipment The old factory machine should be replaced eTextbook and Media 613200 i i 613200 $ $ Replace Equipment 508,100 484,500 -31,600 961000 $ $ Net Income Increase…arrow_forwardTrillian Ltd. is considering replacing a piece of old machinery. The machine has a book value of $80,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient machine is available at a cost of $300,000 that will have a 3-year useful life with no salvage value. The new machine will lower annual variable production costs from $520,000 to $410,000 for each of the next three years. What will the net savings be over the next three years if Trillian buys the new machinery?arrow_forwardElmdale Company has a machine that affixes labels to bottles. The machine has a book value of $80,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient machine is available at a cost of $300,000 that will have a 5-year useful life with no salvage value. The new machine will lower annual variable production costs from $520,000 to $410,000.Prepare an analysis showing whether the old machine should be retained or replaced. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)   Retain Equipment  Replace Equipment  Net Income Change   New machine costVariable manufacturing costsFixed manufacturing costsNet savings over 3 years  $   $   $    Variable manufacturing costsNet savings over 3 yearsFixed manufacturing costsNew machine cost         Net savings over 3 yearsVariable manufacturing costsNew machine costFixed manufacturing costs…arrow_forward
- Elmdale Company has a machine that affixes labels to bottles. The machine has a book value of $80,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient machine is available at a cost of $300,000 that will have a 3-year useful life with no salvage value. The new machine will lower annual variable production costs from $520,000 to $410,000. Prepare an analysis showing whether the old machine should be retained or replaced. (If the net income change is negative, enter the amounts using either a negative sign preceding the number e.g. -45 or parenthesis e.g. (45). Do not leave any answer field blank. Enter O for amounts.) $ Retain Equipment $ Replace Equipment $ $ Net Income Changearrow_forwardBallard MicroBrew is considering the purchase of an automated bottling machine for $55,000. The machine would replace an old piece of equipment that costs $14,000 per year to operate. The new machine would cost $6,000 per year to operate. The old machine currently in use is fully depreciated and could be sold now for a salvage value of $20,000. The new machine would have a useful life of 10 years with no salvage value. Required: 1. What is the annual depreciation expense associated with the new bottling machine? 2. What is the annual incremental net operating income provided by the new bottling machine? 3. What is the initial investment used for calculating the machine's simple rate of return? 4. What is the simple rate of return on the new bottling machine? Note: Round your answer to 1 decimal place i.e. 0.123 should be considered as 12.3%. 1. Depreciation expense 2. Incremental net operating income 3. Initial investment 4. Simple rate of return %arrow_forwardStarling Co. is considering disposing of a machine with a book value of $24,400 and estimated remaining life of five years. The old machine can be sold for $5,100. A new high-speed machine can be purchased at a cost of 69,900. It will have a useful life of five years and no residual value. It is estimated that the annual variable manufacturing costs will be reduced from $23,000 to $19,800 if the new machine is purchased. The five-year differential effect on profit from replacing the machine is a(n) Oa. decrease of $63,440 Ob. decrease of $48,800 Oc. increase of $48,800 Od. increase of $63,440arrow_forward
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