Felton Company has a factory machine with a book value of $90,000 and a remainin

Question

Felton Company has a factory machine with a book value of $90,000 and a remaining useful life of 4 years. A new machine is available at a cost of $200,000. This machine will have a 4-year useful life with no salvage value. The new machine will lower annual variable manufacturing costs from $600,000 to $440,000. Prepare an analysis showing whether the old machine should be retained or replaced. (If an amount should be blank, enter a zero. All boxes must be filled to be correct. If amount decreases net income, use either a negative sign preceding the number eg -45 or parentheses eg (45).)

Explanation / Answer

Working : (4Years * $600,000=$2,400,000) 4Years * $440,000 = $1,760,000) In this case it would be to the company's advantage to replace the equipment. The lower variable manufacturing costs due to replacement more than offset the cost of the new equipment. One other point should be mentioned regarding Felton company's decision, the book value of the old machine does not affect the decision. Book value is a sunk cost, which is a cost that cannot be changed by any present or future decision.Sunk costs are not relevant in incremental analysis. Details Retain Equipment Replace equipment Net income (Increase or decrease variable manufacturing costs($600,000*4) $2,400,000 $1,760,000 $640,000 New machine cost                   0 $200,000 ($200,000) Total $2,400,000 $1,960,000 $440,000

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