Question

Machine Replacement Decision

A company is considering replacing an old piece of machinery, which cost $600,500 and has $351,500 of accumulated depreciation to date, with a new machine that has a purchase price of $487,000. The old machine could be sold for $61,100. The annual variable production costs associated with the old machine are estimated to be $157,200 per year for eight years. The annual variable production costs for the new machine are estimated to be $101,700 per year for eight years.

a.1 Prepare a differential analysis dated May 29 to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine. If an amount is zero, enter "0". If required, use a minus sign to indicate a loss.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 29
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effects (Alternative 2)
Revenues:
Proceeds from sale of old machine	$	$	$
Costs:
Purchase price
Variable productions costs (8 years)
Profit (Loss)	$	$	$

a.2 Determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine.

b. What is the sunk cost in this situation?

The sunk cost is $.

Answer 1

a1
	Continue with old machine	Replace old machine	Differential effect on income
	(Alternative 1)	(Alternative 2)	(Alternative 2)
Revenues
Proceeds from sale of old machine	0	61100	61100
Costs
Purchase price	0	-487000	-487000
Variable production costs (8 years)	-1257600	-813600	444000
Income (loss)	-1257600	-1239500	18100
a2
Replace the old machine
b
The sunk cost is	249000	=600500-351500
Workings:
	(Alternative 1)	(Alternative 2)
Variable production costs (8 years)	=157200*8	=101700*8