Kenta Electronics purchased a manufacturing plant four years ago for $9,000,000.
ID: 2416027 • Letter: K
Question
Kenta Electronics purchased a manufacturing plant four years ago for $9,000,000. The plant cost $2.000,000 per year to operate. Its current book value using straight line depreciation is $7,000,000. Kenta could purchase a replacement plant for $16,000,000 that would have a useful life of 10 years. Because of new technology, the replacement plant would require only $600,000 per year in operating expense. It would have an expected salvage value of $4,000,000 after 10 years. The current disposal value of the old plant is $1,200,000, and if Kenta keeps it 10 more years, its residual value would be $300,000.
Based on this information, should Kenta replace the old plant? Support your answer with appropriate computations.
Explanation / Answer
Incremental approach :
Saving in operating cost for 10 years = $ (2,000,00 - 600,000) *10 years = 14,000,000
Salvage value of new plant after 10 years = $ 4,000,000
Salvage value of old plant presently = $ 1,200,000
Salvage value of old plant after 10 years forgone = $(300,000)
Cost of new plant = ($16,000,000)
Net saving = 14,000,000, + $4,000,000 +$1,200,000 -$300,000 -$16,000,000
= 2,900,000
Since replacement cost is positive so the company should buy the new plant.
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