CariTech (CT) Company produces and sells 7,000 Special purpose chairs per year at a selling price of $850 each. Its current production equipment, purchased for $1,850,000 and with a five-year useful life, is only two years old. It has a terminal disposal value of $0 and is depreciated on a straight-line basis. The equipment has a current disposal price of $500,000. However, the emergence of a new technology has led CT to consider either upgrading or replacing the production equipment. The following table presents data for the two alternatives: A B C 1 Choice Upgrade Replace 2 One-time equipment costs $3,000,000 $4,800,000 3 Variable manufacturing cost per chair $150 $70 4 Remaining useful life of equipment (years) 3 3 5 Terminal disposal value of equipment 0 0 Required 1) Should CT upgrade its production line or replace it? Show your calculations. 2) Suppose the one-time equipment cost to replace the production equipment is negotiable. All other data are as given previously. What is the maximum one-time equipment cost that CT would be willing to pay to replace the old equipment rather than upgrade it? 3) Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but that the production and sales quantity is not known. For what production and sales quantity would CT (i) upgrade the equipment or (ii) replace the equipment? 4) Assume that all data are as given in the original exercise. Thom Son is CT’s manager, and his bonus is based on operating income. Because he is likely to relocate after about a year, his current bonus is his primary concern. Which alternative would Thom Son choose? Explain.
Problem Set 1
CariTech (CT) Company produces and sells 7,000 Special purpose chairs per year at a selling
price of $850 each. Its current production equipment, purchased for $1,850,000 and with a
five-year useful life, is only two years old. It has a terminal disposal value of $0 and is
However, the emergence of a new technology has led CT to consider either upgrading or
replacing the production equipment. The following table presents data for the two
alternatives:
A B C
1 Choice Upgrade Replace
2 One-time equipment costs $3,000,000 $4,800,000
3 Variable
4 Remaining useful life of equipment (years) 3 3
5 Terminal disposal value of equipment 0 0
Required
1) Should CT upgrade its production line or replace it? Show your calculations.
2) Suppose the one-time equipment cost to replace the production equipment is negotiable.
All other data are as given previously. What is the maximum one-time equipment cost that
CT would be willing to pay to replace the old equipment rather than upgrade it?
3) Assume that the capital expenditures to replace and upgrade the production equipment are
as given in the original exercise, but that the production and sales quantity is not known. For
what production and sales quantity would CT (i) upgrade the equipment or (ii) replace the
equipment?
4) Assume that all data are as given in the original exercise. Thom Son is CT’s manager, and
his bonus is based on operating income. Because he is likely to relocate after about a year, his
current bonus is his primary concern. Which alternative would Thom Son choose? Explain.
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