Assignment Task:
Applying Differential Analysis to Equipment Replacement Decision
TaylorMade-Adidas Golf Company a subsidiary of Adidas, manufactures golf clubs using "adjustable weight technology" or AWT. Suppose a European machine company has proposed to sell TaylorMade a new highly automated machine that would reduce significantly the labor cost of producing its golf clubs. The cost of the machine is $3,000,000, and would have an expected life of six years, at the end of which it would have a residual value of 10% of its original cost. The machine has an estimated operating cost of $15,000 per month. The direct labor cost savings per club from using the machine is estimated to be $6 per club, per month. In addition, other fixed overhead costs of $8,000 per month would be eliminated if the new machine is purchased. Also, the new machine would free up about 5,000 square feet of space from the displaced workers. Assume TaylorMade's building is held under a 10-year lease that has eight years remaining. The current lease cost is $1 per square foot per month. TaylorMade has received an offer to rent the excess space to a nearby related company for $3,500 per month for the next two years. (Rental beyond that two year-period is not certain.)
a. Assuming the new machine would be used to produce an average of 8,000 clubs per month, prepare a differential analysis of the relevant costs of buying the machine and using it for the next six years, versus continuing with the current process. Calculate the net advantage or disadvantage of purchasing the new machine.
b. Suppose the cost of the machine is expected to increase by 5%. If the price increase is in effect, how does your answer to part a change?