A sawmill is facing increasing costs partly due to increases in fuel prices. Managers have been…

A sawmill is facing increasing costs partly due to increases in fuel prices. Managers have been discussing different strategies to reduce these costs. They agreed to replace a machine acquired 5 years ago at a cost of $83,000. The market value of the old machine is $7,000 and it could still be used for 2 more years. The new machine costs $116,000 and is expected to last 5 years, with an expected salvage value of $10,000.

The sawmill production costs per unit are as follows:

Direct materials ……………………………..$1.00

Direct labour …………………………………1.30

Overhead (fixed and variable) ………………0.80

Total …………………………………………$3.10

The price charged by the sawmill for one unit of lumber is $6.00 and 100,000 units are sold each year. With the new machine, management expects to save 20% on all variable costs. The desired before-tax rate of return is 25%, the capital cost allocation rate is also 25%, and the company tax rate is 40%. The fixed portion of overhead costs is 60%.

REQUIRED

A. Determine the net present value of the replacement machine.

B. Indicate whether the company should replace its old machine. Justify your answer, and identify some factors that management should consider before making a final decision?

A sawmill is facing increasing costs partly due to increases

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