Question

A company is considering replacing an old piece of machinery, which cost $607,400 and has $368,800 of accumulated depreciation to date, with a new machine that has a purchase price of $557,000. The old machine could be sold for $234,900. The annual variable production costs associated with the old machine are estimated to be $60,200 per year for eight years. The annual variable production costs for the new machine are estimated to be $17,300 per year for eight years.

	Required:
a.	Prepare a differential analysis dated September 13 to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine. Refer to the lists of Labels and Amount Descriptions for the exact wording of the answer choices for text entries. For those boxes in which you must enter subtracted or negative numbers use a minus sign. If there is no amount or an amount is zero, enter "0". A colon (:) will automatically appear if required.
b.	Determine whether the company should continue with (Alternative 1) or replace (Alternative 2) the old machine.
c.	What is the sunk cost in this situation?

Answer 1

a)

	Continue with old machine	Replace old machine	Differential effect on income
Revenues:
Proceeds from sale of old machine	0	234,900	234,900
Costs:
Purchase price	0	- 557,000	- 557,000
Variable production costs (8 years)	- 481,600	- 138,400	343,200
Income (loss)	- $481,600	- $460,500	$21,100

Variable production costs (8 years) of old machine = 60,200 x 8

= $481,600

Variable production costs (8 years) of new machine = 17,300 x 8

= $138,400

b)

Old machine should be replaced by the new machine. Replacing old machine will provide an income of $21,100

c)

Book value of old machine = Cost - accumulated depreciation

= 607,400 - 368,800

= $238,600

sunk cost = Book value of old machine

= $238,600

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