Cornerstone Bank paid $90,000 for a check-sorting machine 10 years ago this month. The machine had an estimated life of 15 years and annual operating costs of $40,000, excluding depreciation. Although management is pleased with the machine, recent technological advances have made check-sorting ma-chines obsolete. Consequently, the machine now has a book value of $30,000, a remaining operating life of five years, and a salvage value of $0.The manager of operations is evaluating a proposal to acquire check scanning equipment for all branches. The new equipment would cost $50,000 and reduce annual operating costs to $20,000, ex-cluding depreciation. Because of expected technological improvements, the manager believes the new machine will have an economic life of four years and no salvage value at the end of that life. Prior to signing the papers authorizing the acquisition of the new machine, the president of the bank prepared the following analysis: Six-year savings ((S40,000 - $20,000) * 4 years) $80,000
Cost of new machine (50,000)
Loss on disposal of old machine (30,000)
Advantage (disadvantage) of replacement $0
After looking at these numbers, the manager rejected the proposal and commented that he was "tired of looking at marginal projects. This bank is in business to make a profit, not to break even. If you want to break even, go work for the government."
Required:
a. Evaluate the president's analysis.
b. Prepare a differential analysis of six-year totals for the old and the new machines.
c. Speculate on some limitations of the model or other issues that might be a factor in making a final decision.