Question

Asset replacement

Certain production equipment used by Dayton Mechanical has become obsolete relative to current technology. The company is considering whether it should keep or replace its existing equipment. To aid in this decision, the company’s controller gathered the following data:

Old Equipment New Equipment

Original cost $980,000 $1,108,800

Remaining life 5 years 5 years

Accumulated depreciation $442,400 $0

Annual cash operating costs $179,200 $44,800

Current salvage value $246,400   NA

Salvage value in five years $0 $0

a. What is the total dollar amount of all relevant costs to the equipment replacement decision. $

b. What is the total dollar amount of the opportunity costs associated with the alternative of keeping the old equipment? $

c. What is the incremental cost to purchase the new equipment? $

Answer 1

Solution:

a. Relevant Costs for the replacement of a new equipment is

Cost of new equipment = $1,108,800

Salvage Cost of existing machine = $246,400

Savings in operating costs = ($179,200 - $44,800) = $134,400

b. Opportunity costs = $134,400 + $246,400 = $380,800

c.Incremental cost of purchasing new equipment = Cost of purchase of new machine - Salvage value of existing machine = $1,108,800 - $246,400 = $862,400

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