Question

Relevant Costs for Equipment Replacement Decision
Health Scan, Inc. paid $50,000 for X-ray equipment four years ago. The equipment was expected to have a useful life of 10 years from the date of acquisition with annual operating costs of $35,000. Technological advances have made the machine purchased four years ago obsolete with a zero salvage value. An improved X-ray device incorporating the new technology is available at an initial cost of $43,000 and annual operating costs of $23,000. The new machine is expected to last only six years before it, too, is obsolete. Asked to analyze the financial aspects of replacing the obsolete but still functional machine, Health Scan's accountant prepared the following analysis. After looking over these numbers, the Center's manager rejected the proposal.

Six-year savings [($35,000 − $23,000) × 6]	$72,000
Cost of new machine	(43,000)
Undepreciated cost of old machine	(30,000)
Advantage (disadvantage) of replacement	$(1,000)

Calculate the net benefit (cost) of purchasing the new machine.
$Answer

Answer 1

Savings $72000

less:cost of machine $-43000

Advantage   $29000

Cost of old machine is a sunk cost thus irrelevant while making decision.

Management has made a wrong decision regarding replacement of old machine.