Mountain Gear has been using the same machines to make its name-brand clothing for the last five years. A cost efficiency consultant has suggested that production costs may be reduced by purchasing more technologically advanced machinery. The old machines cost the company $290,000. The old machines presently have a book value of $129,000 and a market value of $21,000. They are expected to have a five-year remaining life and zero salvage value. The new machines would cost the company $190,000 and have operating expenses of $18,000 a year. The new machines are expected to have a five-year useful life and no salvage value. The operating expenses associated with the old machines are $39,000 a year. The new machines are expected to increase quality, justifying a price increase and thereby increasing sales revenue by $19,000 a year. Select the true statement.

Mountain Gear has been using the same machines to make its name-brand clothing for the last five years. A cost efficiency consultant has suggested that production costs may be reduced by purchasing more technologically advanced machinery. The old machines cost the company $290,000. The old machines presently have a book value of $129,000 and a market value of $21,000. They are expected to have a five-year remaining life and zero salvage value. The new machines would cost the company $190,000 and have operating expenses of $18,000 a year. The new machines are expected to have a five-year useful life and no salvage value. The operating expenses associated with the old machines are $39,000 a year. The new machines are expected to increase quality, justifying a price increase and thereby increasing sales revenue by $19,000 a year. Select the true statement.

Explanation

The relevant costs for the two machines:
 

Old Machines					New Machines
Opportunity cost (1)	$	21,000			Cost of new machine	$	190,000
Salvage value		none			Operating revenues (2)		(95,000	)
Operating expenses (3)		195,000			Operating expenses (3)		90,000
Total	$	216,000			Total	$	185,000

 

1. (1) This represents the current sacrifice the company must make if it keeps using the existing machine. In other words, if the company does not keep the machine, it can sell it for this amount.
2. (2) New machine: $19,000 × 5 years = $95,000
3. (3) Old machine: $39,000 × 5 years = $195,000; New machine: $18,000 × 5 years = $90,000

Over the five-year period, the company would save $31,000 ($216,000 − $185,000) by purchasing the new machine.

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