Question

Cain’s Tool & Die paid $397,000 in cash for a piece of equipment three years ago. Last year, the company spent $52,000 on equipment upgrades. The equipment is being depreciated using the straight-line method over seven years. The company no longer uses this equipment in its current operations and has received an offer of $125,000 from a firm that would like to purchase it. If the company should decide to use this equipment in an upcoming project, what cost, if any, should be assigned to the project for this equipment?

Answer 1

The cost of equipment to be assigned for the project is based on relevant cost analysis. The book value of the equipment in the given situation is irrelevant cost. The book value of the equipment is original purchase cost + additional cost minus accumulated depreciation. The net book value is also referred to as the sunk cost. A sunk cost is the cost which is incurred in past and not relevant for current decision making. Hence the new project to be undertaken by the firm will not include the original cost of asset or the net book value of the asset after accumulated depreciation.

The only relevant cost in the new project will be the realisable value of the equipment. The realisable value of equipment is $125,000 which will be assigned to the equipment in the project. Realisable value of the equipment is relevant cost required for decision making.