AMIS 525

Equipment Replacement

A company has a contract to produce and sell 2,000 units per year for the next five years. Additional customers might be found at the same price as the contract customer. The contribution margin per unit is $9. A machine purchased 9 years ago for $84,000 is used exclusively to make this product. The machine will last for five more years and then have a zero value. The current value is $5,000. A new machine might be leased for $16,000 per year for five years to replace the old machine. Situation A Operating characteristics of the two machines are: machine capacity per period old 6000 new 6000

operating cost per unit $5 $2

What number of additional [noncontract] units each year would be needed to make the two machines equal in cost [incremental fixed and variable] over the five year period?

Situation A Calculations: $5 * Q $3 * Q = = [(5 * $16,000) - $5,000] + [$2 * Q] $75,000

note: Q is five year total amount Q= 25,000

TOTAL FOR 5 YEARS EACH YEAR

25,000 / 5 = 5,000 5,000 - 2,000 = 3,000

ADDITIONAL EACH YEAR

All other facts unchanged. Situation B Operating characteristics of the two machines are: machine capacity per period old 4000 new 6000

operating cost per unit $5 $2

What number of additional [noncontract] units each year would be needed to make the new machine equal in profitability to the old machine over the five year period?

Situation B Calculations: 5 * [$9 * 4,000] = $180,000

TOTAL CONTRIBUTION OF OLD MACHINE AT CQ = 4,000 UNITS

-[(5 * $16,000) - $5,000] + [ 5 * [$12 * Q] ] TOTAL CONTRIBUTION OF NEW = -$75,000 + [ $60 * Q] note: Q is annual amount -$75,000 + [ $60 * Q] $60 * Q Q = = = $180,000 $255,000 4,250 EQUIVALENT PROFIT LEVEL OF PRODUCTION FOR EACH YEAR

1/9/2014