Question

Creekside Products Inc. is considering replacing an old piece of machinery, which cost $315,000 and has $130,000 of accumulated depreciation to date, with a new machine that costs $275,000. The old machine could be sold for $140,000. The annual variable production costs associated with the old machine are estimated to be $30,000 for eight years. The annual variable production costs for the new machine are estimated to be $9,000 for eight years.

a. Determine the total and annualized differential income or loss anticipated from replacing the old machine. Enter all amounts as positive numbers.

Net differential	income	$
Annual differential	income	$

b. What is the sunk cost in this situation?
$,   the book value of the present equipment.

Answer 1

a) Calculation of Net differential and Annual differential:

	Continue with Old Machine	Replace Old Machine	Differential effect on Income
Revenues:
Proceeds from sale of old machine	0	140,000	140,000
Costs:
Purchase	0	-275,000	-275,000
Variable productions costs	-240,000	-72,000	168,000
	-240,000	-207,000	33,000

Net differential income = 33,000

Annual differential income = 33000/8

= 4,125

b) Calculation of sunk cost:

Sunk cost = 315,000-130,000

= 185,000