Last year (2016), Richter Condos installed a mechanized elevator for its tenants

Question

Last year (2016), Richter Condos installed a mechanized elevator for its tenants. The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator's speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked the company’s accountant to provide him with cost data on the company’s elevator. This information is presented below. Old Elevator New Elevator Purchase price $103,500 $161,000 Estimated salvage value 0 0 Estimated useful life 5 years 4 years Depreciation method Straight-line Straight-line Annual operating costs other than depreciation: Variable $34,600 $10,000 Fixed 23,600 8,800 Annual revenues are $239,000, and selling and administrative expenses are $29,000, regardless of which elevator is used. If the old elevator is replaced now, at the beginning of 2017, Richter Condos will be able to sell it for $24,400.

Prepare a 4-year summarized income statement for each of the following assumptions:

(1) The old elevator is retained.

the old elevator is replaced.
Using incremental analysis, determine if the old elevator should be replaced.

Explanation / Answer

(1) The old elevator is retained. Sales ($239,000 × 4 years) $956,000 Less: Variable costs ($34,600 × 4) $138,400 Less: Fixed costs ($23,600 × 4) $94,400 Less: Selling & administrative ($29000 x 4) $116,000 Less: Depreciation = $103,500 /5 x 4 $82,800 Total Cost -$431,600 Net Income $524,400 (2) The old elevator is replaced. Sales ($239,000 × 4 years) $956,000 Less: Variable costs ($10,000 × 4) $40,000 Less: Fixed costs ($8,800 × 4) $35,200 Less: Selling & administrative ($29000 x 4) $116,000 Less: Depreciation $161,000 Total Cost -$352,200 Operating Income $603,800 Less: Loss on old elevator -58400 Net Income $545,400 Loss on Old Elevator Purchases $103,500.00 Less: Accumulated depreciation ($103500/5) $20,700 Book Value $82,800 Less: Sales proceeds $24,400 Loss on Old Elevator $58,400 Using incremental analysis, determine if the old elevator should be replaced. Retain Old Elevator Replace old Elevator Net IncomeIncrease(Decrease Variable operating costs $138,400 $40,000 $98,400 Fixed operating costs $94,400 $35,200 $59,200 New elevator cost 161000 -$161,000 Salvage on old elevator 24400 $24,400 Totals $232,800 $260,600 $21,000

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