Question

As the senior accountant at Jackson Quality Sportswear (JQS), which manufactures sport attire for men, women, youth, and children, you are often asked to prepare various financial analysis necessary for decision making. Jacob Reynolds, the controller, asked you to evaluate whether a piece of factory equipment should be replaced or kept.

The old piece of factory equipment was purchased four years ago for $850,000. Over the last four years, JQS has allocated depreciation based on the straight-line method. The expected salvage value is $25,000. The current book value of the factory equipment is $520,000. The operating expenses total approximately $40,000 a year. It is estimated that the residual value (market value) of the old machine is $300,000.      

The controller is contemplating whether to replace the piece of factory equipment. The replacement factory equipment would consist of a purchase price of $400,000, a useful life of eight years, salvage value of 20,000, and annual operating costs of $25,000.

In evaluating the “relevant” costs, what does your analysis show? Do you recommend that the equipment be replaced or kept ongoing for the next eight years? Why or why not?

Answer 1

Year	Equipment to be replaced			Old equipment to be kept
1	Replacement Purchase	-4,00,000.00
1	Sale of old machine	3,00,000.00
1	Operating Exp	-25,000.00		Operating Exp	-40,000.00
2	Operating Exp	-25,000.00		Operating Exp	-40,000.00
3	Operating Exp	-25,000.00		Operating Exp	-40,000.00
4	Operating Exp	-25,000.00		Operating Exp	-40,000.00
5	Operating Exp	-25,000.00		Operating Exp	-40,000.00
6	Operating Exp	-25,000.00		Operating Exp	-40,000.00
7	Operating Exp	-25,000.00		Operating Exp	-40,000.00
8	Operating Exp	-25,000.00		Operating Exp	-40,000.00
8	Salvage value	20,000.00		Salvage value	25,000.00
		-2,80,000.00			-2,95,000.00

It is better to replace the old equipment. since the cash outflow will decrease by $15000.

Depreciation expenses is not considered since it does not result in actual outflow of cash.

In addition, required data for compuation of depreciation is not provided