The Plant Manager Is Aware of a New Piece of Specialized Equipment That Should Reduce The

The Plant Manager Is Aware of a New Piece of Specialized Equipment That Should Reduce The

One of Eastvaco’s business segments involves the manufacturing of laser printers. Each printer sells for $400. The profit margin on the printers have not met the expectations of the Company’s CEO. He approaches the Plant Manager of the printer plant and asks for suggestions to improve the margin earned on printer sales. The Plant Manager explains to the CEO that increasing the sales price ($400) or sales quantity (50,000) is not possible in such a highly competitive market. Therefore, a reduction is cost may be the only possibility.

The Plant Manager is aware of a new piece of specialized equipment that should reduce the amount of labor required to produce the printers. The Plant Manager has come to you to prepare a schedule evaluating the two alternatives of keeping the old machine or purchase the new machine. To complicate matters, the plant manager receives a bonus on operating income, beginning next year. The following is data relating to the two machines.

Existing MachineNew Machine

Original Cost$300,000$135,000

Useful life5 years3 years

Current age2 years0 years

Remaining useful life3 years3 years

Accumulated depreciation$120,0000

Current book value$180,000not purchased yet

Current disposal value$95,000not purchased yet

Savage value in 3 years00

Annual cash operating costs$40,000$10,000

Annual revenues$1,000,000$1,000,000

Annual other operating costs$880,000$880,000

Required:

Ignoring the time value of money should Eastvaco keep the old machine or purchase the new one? Review the concept of relevant cost. You will need to apply the concept of relevant cost to this problem..Prepare an income statement (combine three years into one combined income statement) showing which alternative would be best. Start the income statement with next year. Do not consider any costs this year since the plant manager is concerned about his bonus for the next three years.

One of Eastvaco’s business segments involves the manufacturing of three types of book binders. The profit margin on the binders have not met the expectations of the Company’s CEO. He approaches the Plant Manager of the binder plant and asks for suggestions to improve the margin earned on binder sales. The Plant Manager explains to the CEO that increasing the sales price or sales quantity is not possible in such a highly competitive market. Therefore, a reduction in cost may be the only possibility.

The plant manager has the plant controller prepare a segment income statement for each of the three binders. The difference among the binders relates to quality.

Binder ABinder BBinder CTotal

Sales Revenue (given in thousands)$500$800$150$1,450

Less Variable expenses250 480 140 870

Contribution Margin$250$320$ 10 580

Less direct fixed expenses

Advertising 10 10 10 30

Salaries37 40 35 112

Depreciation 53 4010 103

Total$100$ 90$ 55$ 245

Segment margin$150$ 230$ (45)$ 335

Less common fixed expenses$ 125

Operating Income$ 210

The controller explains that if Binder C was discontinued then the supervisor (represents salaries) could be dismissed. Also, there would be no need for advertising Binder C.

Required:

1. Should Binder C be discontinued? Provide calculations to support your answer.

2. What other consideration(s) should the company consider before dropping Binder C?