Re l ev an c e of equipment c o s ts.
Jääskinen Oy has just today paid for and installed a special machine for polishing cars at one of its several outlets. It is the first day of the company’s fiscal year. The machine cost
€20 000. Its annual operating costs total €15 000, exclusive of depreciation. The machine
will have a four-year useful life and a zero terminal disposal price.
After the machine has been used for a day, a machine salesperson offers a different machine that promises to do the same job at a yearly operating cost of €9000, exclusive of depreciation. The new machine will cost €24 000 cash, installed. The ‘old’ machine is unique and can be sold outright for only €10 000, minus €2000 removal cost. The new machine, like the old one, will have a four-year useful life and zero terminal disposal price.
Sales, all in cash, will be €150 000 annually, and other cash costs will be €110 000 annually, regardless of this decision.
For simplicity, ignore income taxes, interest and present-value considerations.
1 a Prepare a statement of cash receipts and disbursements for each of the four years under both alternatives. What is the cumulative difference in cash flow for the four years taken together?
b Prepare income statements for each of the four years under both alternatives. Assume straight-line depreciation. What is the cumulative difference in operating profit for the four years taken together?
c What are the irrelevant items in your presentations in requirements (a) and (b)? Why are they irrelevant?
2 Suppose the cost of the ‘old’ machine was €1 million rather than €20 000. Nevertheless, the old machine can be sold outright for only €10 000, minus €2000 removal cost. Would the net differences in requirements 1 and 2 change? Explain.
3 ‘To avoid a loss, we should keep the old machine.’ What is the role of book value in deci- sions about replacement of machines?