Question

Bavaria Inc. 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	$ 225,000	$ 375,000
Accumulated Depreciation	$ 90,000	-0-
Annual Operating Costs	$ 300,000	$ 240,000

If the old equipment is replaced now, it can be sold for $60,000. Both the old equipment’s remaining useful life and the new equipment’s useful life is 5 years.

Bavaria should a.keep the old machine, b.buy the new machine

because it will save Bavaria a.15,000, b.60,000, c.75,000, d.90,000, e.another amount other than these shown

Answer 1

Incremental analysis

	Continue with old machine	Replace old machine	Differential effect on income
Revenues:
Proceeds from sale of old machine	0	60,000	60,000
Costs:
Purchase price	0	- 375,000	- 375,000
Operating costs (5 years)	- 1,500,000	- 1,200,000	300,000
Income (loss)	- $1,500,000	- $1,515,000	- $15,000

Operating costs (5 years) of old machine = Annual operating costs x 5

= 300,000 x 5

= $1,500,000

Operating costs (5  years) of new machine = Annual operating costs x 5

= 240,000 x 5

= $1,200,000

Bavaria should keep the old machine because it will save Bavaria $15,000

Correct option is (a)