Posted: July 29th, 2016

What is a hurdle expected?

ABC Company is a company that employs only people with physical or mental disabilities. One of the organization’s activities is to make cookies for its snack food store. Several years ago, ABC Company purchased a special cookie-cutting machine. As of December 31, 2010, this machine will have been used for three years.

Management is considering the purchase of a newer, more efficient machine. If purchased, the new machine would be acquired on December 31, 2010. Management expects to sell 300,000 dozen cookies in each of the next six years. The selling price of the cookies is expected to average $1.15 per dozen.

The ABC Company has two options:
1. Continue to operate the old machine, or
2. Sell the old machine and purchase the new machine.

No trade-in was offered by the seller of the new machine. The following information has been assembled to help management decide which option is more desirable.
Old New
Machine Machine
Original cost of machine at acquisition……………………..$80,000 $120,000
Remaining useful life as of December 31, 2010…… 6yrs 6yrs
Expected annual cash operating expenses:
Variable cost per dozen……………………………… $.38 $.29
Total fixed costs…………………………………….. $21,000 $11,000

Assume that all operating revenues and expenses occur at the end of the year.

Required:
1. Use the net-present-value method to determine whether the ABC Company should retain the old machine or acquire the new machine. The organization’s hurdle rate is 16 percent.
2. Independent of your answer to requirement (1), suppose the quantitative differences are so small between the two alternatives that management is indifferent between the two proposals. Write a memo to the president of SPI that identifies and discusses any non-quantitative factors that management should consider.