For a production manager, deciding whether to replace a machine or repair it in case of a breakdown is an expensive guess. It saves money to buy a new machine if the repairs are frequent. However, the company may undergo losses if it spends money on a bad machine. It is thus important for the managers to evaluate the viability of the options they are to choose.
For the owner of the engraving business, it would be wise to replace the engraver with a new one instead of suffering the losses from 18 days of breakdown. The new engraver will have a cost equal to its principal amount and the interest on the loan thereby totaling to 28,000 dollars. This amount would be repaid within 115 days if the profits from the business are to be used to repay the loan. However, the owner would miss out on profits for 115 days but it would be worthwhile in the long run.
Conversely, if the owner decides to keep the engraver, he would incur a loss in revenue of $17,550 and a net loss of $4,387.50 when the machine breaks down. The machine will also be outdated in a couple of years thus will need replacement in future. It would be wise to replace the machine as it would have realized the cost of the loan before the repayment time is due.
Before buying the engraver, the owner should consider its resale value in case he wants to update it in future. He would also consider the technological advances on the engraver to avoid buying a machine that would become obsolete within a short time in addition to the cost of future repairs since as more a product advances in technology, the more expensive its repair gets (Zuo, Liu & Murthy, 2000).
Cost of new engraver in total if the full value is financed by a 12% loan exclusive of tax.
Cost of loan = Interest + principal amount (Brooks & Mukherjee, 2013)
Interest = principal amount*time of loan*rate
= $25,000*1*12% = $3,000
Cost of loan = $25,000 + $3000 = $28,000
Total amount of revenue that could be lost if the engraver breaks down for 18 business days.
$975*18 = $17,550
Amount of net profit that could be lost if the engraver breaks
Net profit = 25% of Revenue
Time to pay for the engraver if the entire net profit is allocated toward paying for it
Profits per day = 25%*975 = $243.75
$28,000/$243.75 = 114.9 days = 115 days.