The capital budgeting committee of the Caldwell Pipe Corporation is evaluating the possibility of replacing its old pipe-bending machine with a more advanced model. Information on the existing machine and the new model follows: Existing machine New machine Original cost $200,000 $400,000 Market value now 80,000 Market value in year 5 0 20,000 Annual cash operating costs 40,000 10,000 Remaining life 5 yrs 5 yrs Refer to Caldwell Pipe Corporation. If the company buys the new machine and disposes of the existing machine, corporate profit over the five-year life of the new machine will be than the profit that would have been generated had the existing machine been retained for five years.

Caldwell Pipe Corporation

If the company buys the new machine and disposes of the existing machine, corporate profit over the five-year life of the new machine will be ___$150,000 than the profit that would have been generated had the existing machine been retained for five years.

Explanation:

a) Data and Calculations:

                                                    Existing machine    New machine

Original cost                                     $200,000              $400,000

Market value now                                 80,000

Market value in year 5                          0                           20,000

Annual cash operating costs               40,000                   10,000

Remaining life                                        5 yrs                       5 yrs

Total cash operating costs             $200,000               $50,000

Difference between the annual cash operating costs = $150,000 ($200,000 - $50,000)

b) Corporate profit is based on the difference between the net revenue and the cost of operations.  With the old machine, the total cash operating costs after 5 years will be $200,000 ($40,000 * 5).  On the other hand, with the new machine, the total cash operating costs after 5 years will be $50,000 ($10,000 * 5).  This makes an operating cost difference of $150,000 ($200,000 - $50,000).

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