Reference no: EM132571408

Question - A component product is presently being manufactured using equipment that is fully depreciated. With suitable annual overhauls and an upfront cost of $20,000, it can be used by the company for another three years. The cost of these overhauls is expected to be $40,000 per year (payable at the beginning of each year), and at the end of the third year the overhauled machine is expected to have a salvage value of $10,000.

A new machine can be purchased for $134,350 cash with an expected life of three years and no expected salvage value at the end of three years. The projected sales and cost of operations for both the old and new machines for each of the next three years follow. Assume that the time value of money for this company is 10% per year, and ignore income taxes.

Unit sales per year (via transfers to other production departments) 20,000 20,000

Out-of-pocket operating costs per unit* $8.00/unit $7.50/unit

Required -

a) Should the old machine be overhauled or should the new equipment be acquired? Explain.

b) If the component product can be purchased at a cost of $10.30 per unit from outside suppliers, should it then be purchased or be manufactured internally? Explain. Assume that payments to external suppliers are made at the end of each year.

c) At what level of output (unit sales per year) would management be indifferent to (1) buying the component from outside suppliers at $10.30 per unit, and (2) manufacturing it internally on the new equipment?