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Question - Assume Mitsubishi Chemical is evaluating a proposal to purchase a new compressor that would cost $160,000 and have a salvage value of $16,000 in five years. Mitsubishi's cost of capital is 16%. It would provide annual operating cash savings of $18,000, as follows:
Old Compressor
New Compressor
Salaries
$48,000
$60,000
Supplies
9,600
6,000
Utilities
18,400
12,000
Cleaning and maintenance
28,000
8,000
Total cash expenditures
$104,000
$86,000
If the new compressor is purchased, Mitsubishi will sell the old compressor for its current salvage value of $48,000. If the new compressor is not purchased, the old compressor will be disposed of in five years at a predicted scrap value of $4,800. The old compressor's present book value is $68,000. If kept, the old compressor will require repairs one year from now predicted to cost $60,000.
Required -
a. Use the total cost approach to evaluate the alternatives of keeping the old compressor and purchasing the new compressor. Indicate which alternative is preferred.
b. Use the differential cost approach to evaluate the desirability of purchasing the new compressor.
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