How does a firm go about choosing which Accounting Inventory Method works?
Congratulations! You are a proud owner of an engraving business. However, you are using an aging rotary engraver to engrave plaques and trophies. The machine has been reliable, but does require regular maintenance and periodic replacement of parts. You have just found out that this engraver will no longer be supported by the manufacturer. This means that service and parts will be hard to get in the future, and if it breaks it could take up to three weeks to get a new one up and running. You keep this machine running almost 8 hours a day, every day. Every day that engraver is down will cost around $975 in lost income.
If you have to buy a new engraver, it would cost around $25,000.
You can get a one-year loan at 12% to buy a new engraver, but you worry that this is a lot of money to spend, especially since the old engraver is still working fine. You have to make a decision.
In this discussion, pose your argument on whether you should purchase a new engraver now or wait until the old engraver breaks before ordering a new engraver.
To help you construct your argument answer the following steps:
The local bank will loan you $25,000 for 1 year at an interest rate of 12% with only one payment due at the end of the year. If you borrow the full $25,000 for the new engraver, what will the total cost of the loan be?
Calculate the total amount of revenue (gross profit) that will be lost if the engraver breaks and is down for 18 business days.
If the engraving business makes $975 per day in revenue and generates a net profit of 25%, how much profit is generated per day?
Given a 25% profit margin and $975 per day in revenue, how many days would it take for the new engraver to earn back the total cost of purchase, if the entire net profit were allocated to pay for the unit?
What other factors should you consider in order to make a good business decision?