Refer to 9-A3.
1. Suppose the “decision model favoured by top management consisted of a comparison of a three-year accumulation of wealth under each alternative. Which alternative would you choose? Why? (Accumulation of wealth means cumulative increase in cash.)
2. Suppose the “performance evaluation model emphasized the net income of a subunit, such as a division, each year rather than considering each project, one by one. Which alternative would you expect a manager to choose? Why?
3. Suppose the same quantitative data existed, but the “enterprise ? was a city and the “machine ?was a computer in the treasurer’s department. Would your answers to the first two parts change? Why?
Data From 9-A3
On January 2, 2010, the S.H. Park Company installed a brand-new $90,000 special moulding machine for producing a new product. The product and the machine have an expected life of three years. The machine’s expected disposal value at the end of three years is zero.
On January 3, 2010, Kimiyo Lee, a star salesperson for a machine tool manufacturer, tells Mr. Park, “I wish I had known earlier of your purchase plans. I can supply you with a technically superior machine for $99,000. The machine you just purchased can be sold for $15,000. I guarantee that our machine will save $38,000 per year in cash operating costs, although it too will have no disposal value at the end of three years.
Park examines some technical data. Although he has confidence in Lee’s claims, Park contends, “I’m locked in now. My alternatives are clear: (a) Disposal will result in a loss; (b) keeping and using the ‘old equipment avoids such a loss. I have brains enough to avoid a loss when my other alternative is recognizing a loss. We’ve got to use that equipment until we get our money out of it.
The annual operating costs of the old machine are expected to be $60,000, exclusive of depreciation. Sales, all in cash, will be $910,000 per year. Other annual cash expenses will be $810,000 regardless of this decision. Assume that the equipment in question is the company’s only fixed asset.
Ignore income taxes and the time value of money.
