Machine Replacement Decision A company is considering replacing an old piece of

Question

Machine Replacement Decision

A company is considering replacing an old piece of machinery, which cost $599,400 and has $349,600 of accumulated depreciation to date, with a new machine that has a purchase price of $485,900. The old machine could be sold for $61,500. The annual variable production costs associated with the old machine are estimated to be $155,200 per year for eight years. The annual variable production costs for the new machine are estimated to be $99,900 per year for eight years.

a. Prepare a differential analysis dated April 29, to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine. If an amount is zero, enter zero "0". For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) Replace Old Machine (Alternative 1) (Alternative 2) (Alternative 2) Continue with Old Machine Differential Effect on Income Revenues: Proceeds from sale of old machine Costs: Purchase price Variable productions costs (8 years) Determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine. Machine Replacement Decision b. What is the sunk cost in this situation? The sunk cost is the $

Explanation / Answer

a.

Replace (Alternative 2)

Replacing the machine would result in an increase in income of $18000 over 8 years and hence the company should replace the machine.

b. The sunk cost is the $599400.

The cost of the old machine is a sunk cost.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) April 29 Continue with Old Machine
(Alternative 1) Replace Old Machine
(Alternative 2) Differential Effect on Income
(Alternative 2) Revenues: Proceeds from sale of old machine 0 61500 61500 Costs: Purchase price 0 -485900 -485900 Variable production costs (8 years) -1241600 -799200 442400 Income (Loss) -1241600 -1223600 18000

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