Question

Sunland Company is considering the replacement of a piece of equipment with a newer model. The following data has been collected:

	Old Equipment		New Equipment
Purchase price	$312000		$512000
Accumulated depreciation	124800		- 0 -
Annual operating costs	411000		354000

If the old equipment is replaced now, it can be sold for $85000. Both the old equipment’s remaining useful life and the new equipment’s useful life is 5 years. The company uses straight-line depreciation with a zero salvage value for all of its assets.

The net advantage (disadvantage) (net effect on current year net income) of replacing the old equipment with the new equipment is (don’t consider annual operating costs in the computation)

$(99000)

$124800`

$85000

$(17400)

Answer 1

Solution:

Answer is: $85000

Explanation: The net advantage of replacing the old equipment with the new equipment (without considering annual operating costs in the computation) is $85,000. The revenue from the sale of old equipment $85,000 is the net advantage i.e. there will be a net increase in current year income by $85,000. The book value of old equipment i.e. $187,200 ($312,000-$124,800) is a sunk cost and will not be considered in decision making of replacement of old equipment with the new equipment. Hence, the sale price of old equipment i.e. $85,000 is the net advantage on the replacement of old equipment with the new equipment without considering the annual operating costs in the computation.