Question

Exercise 7-14 (Video)

Johnson Enterprises uses a computer to handle its sales invoices. Lately, business has been so good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the volume of sales invoices. Management is considering updating its computer with a faster model that would eliminate all of the overtime processing.

		Current Machine			New Machine
Original purchase cost		$15,500			$25,100
Accumulated depreciation		$5,900			_
Estimated annual operating costs		$24,900			$19,800
Remaining useful life		5 years			5 years

If sold now, the current machine would have a salvage value of $10,300. If operated for the remainder of its useful life, the current machine would have zero salvage value. The new machine is expected to have zero salvage value after 5 years.

Prepare an incremental analysis to determine whether the current machine should be replaced. (In the first two columns, enter costs and expenses as positive amounts, and any amounts received as negative amounts. In the third column, enter net income increases as positive amounts and decreases as negative amounts. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

		Retain Machine		Replace Machine		Net Income Increase (Decrease)
Operating costs		$		$		$
New machine cost
Salvage value (old)
Total		$		$		$

The current machine should be

retained/replaced

.

Answer 1

Here the cost of old machine is not relevant as it has already been incurred. It is a sunk cost

		Retain Machine		Replace Machine		Net Income Increase (Decrease)
Operating costs		$124,500 [$24,900*5years]		$99,000 [$19,800*5years]		$25,500 [$124,500-99,000]	Income will increase as cost has reduced by using new machine
New machine cost				$25,100		-$25,100 [$0-25,100]
Salvage value (old)				-$10,300		$10,300	Income will increase
Total		$124,500		$113,800		$10,700	Increase in income

The current machine should be replaced

Machine should be replaced as it will save net cost by $10,700

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