Evaluate the alternatives of keeping the old compressor

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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.

Reference no: EM133186696

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