Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 55

Sensitivity Analysis Use the information in problem 12-53 to answer the following questions:

Required

1. What is the maximum machine operating cost of the overhauled AccuDril for the replacement decision to be an incorrect financial decision?

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2. Use the Goal Seek function in Excel to determine the maximum amount that the annual after-tax operating costs for the new machine can be before changing the decision.

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3. New technologies make it possible to overhaul this machine now for $80,000. Both the overhaul cost and the undepreciated cost (book value) of the existing asset are to be depreciated over two years. The overhaul will improve its productivity by 20 percent and reduce the cost of a major overhaul two years from now to $30,000. All overhaul costs will be depreciated using the straight-line method. With either overhaul, the machine will have no salvage value. Either overhaul can be scheduled during regular maintenance and will not affect production. Despite the old saying, “If it ain’t broke, don’t fix it,” should you overhaul it now or wait for two years to do the overhaul as planned originally, assuming that no funds are currently available to purchase RoboDril 1010K?

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4. Performing the overhaul now also improves product quality. Management believes that the quality improvement is rather subtle and very difficult to quantify. Should the firm overhaul now?

Step 1 of 6

The prearrangement of long-term investment in the productive asset is known as capital budgeting. A company uses a diverse mixture of capital sources. Its capital can be raised through new debt or equity or from available cash. The mix of capital is subject to many features like market circumstances and attitude of the members of the board of directors and people of management.