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The RUM Company produces and sells 7,500 modular computer desks per year at a selling...

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Accounting

The RUM Company produces and sells 7,500 modular computer desks per year at a selling price of $750 each. Its current production equipment, purchased for $1,800,000 and with a five-year useful life, is only two years old. It has an estimated salvage value of $0 and is depreciated on a straight-line basis.

Now there is a new molding technology that has led RUM Company to consider either upgrading or replacing the production equipment. If the production equipment is disposed of now, it could be sold at a disposal value of $450,000. The following table presents data for the two alternatives:

Upgrade Replace
$ $
one-time equipment cost 3,000,000 4,800,000
Variables manufacturing cost per desk 150 75
Remaining useful life of equipment(in years) 3 3
Estimated salvage value of equipment 0 0

All equipment costs will continue to be depreciated on a straight-line basis. For simplicity, ignore income taxes and the time value of money.

Required:

a. Should Rum Company upgrade its production line or replace it? Show your calculations and calculate the net book value of the existing equipment. Explain whether the amount of depreciation expense or loss on disposal will affect the decision to upgrade/replace?

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