- 15 Marks
PM – May 2017 – L2 – SA – Q6 – Standard Costing and Variance Analysis
Advise on optimal replacement timing for AL Limited's machine based on cost-benefit analysis.
Question
AL Limited, a manufacturing company based in Aba, produces a popular mortar coloring agent called Hadtone. Hadtone is packaged in five-litre cartons, sold at ₦300 each. Estimated maximum annual demand is 300,000 cartons, justifying one processing machine, replaced every three years though it has a four-year productive life.
- Machine Details: Initial productive capacity aligns with maximum demand, decreasing by 15,000 units per annum. Maintenance costs in year one are ₦300,000, rising by ₦50,000 each subsequent year. Variable costs per carton (excluding maintenance) are ₦200.
- Machine Depreciation: Straight-line method. Sale proceeds after one year are ₦8,000,000, reducing by ₦3,000,000 each following year.
- Machine Cost Increase: Recent machine cost rise to ₦12,000,000 prompts reconsideration of replacement policy to optimize cash flow. Assume all costs/revenues except initial payment occur year-end; initial cost paid at purchase.
Requirements:
a. Calculate replacement frequency based on maximum capacity usage, including supporting calculations. Assume a 10% cost of capital. (12 Marks)
b. Itemize key assumptions made in the calculations. (3 Marks)
Find Related Questions by Tags, levels, etc.
- Tags: Cash Flow, Cost of Capital, Depreciation, Replacement Analysis
- Level: Level 2
- Topic: Standard Costing and Variance Analysis
- Series: MAY 2017
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