Question

At the beginning of last year (2019), Richter Condos installed a mechanized elevator for its tenants. The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator's speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked the company's accountant to provide him with cost data on the company's elevator. This information is presented below. Purchase price Estimated salvage value Estimated useful life Depreciation method Annual operating costs other than depreciation: Variable Fixed Old Elevator New Elevator $98,500 $159,000 0 5 years 4 years Straight-line Straight-line $35,300 24,000 $10,000 8,900 Annual revenues are $239,000, and selling and administrative expenses are $29,000, regardless of which elevator is used. If the old elevator is replaced now, at the beginning of 2020, Richter Condos will be able to sell it for $25,700.

Answer 1

a. Determine any gain or loss if the old elevator is replaced.
Cost	$   98,500.00
Accumulated depreciation (98,500/5)	$  (19,700.00)
Book Value	$   78,800.00
Sales proceeds	$  (25,700.00)
Loss on sale	$   53,100.00
b.Prepare a 4-year summarized income statement for each of the following assumptions
(1) The old elevator is retained.
Sales ($239,000 × 4 years)		$  956,000.00
Less: Variable costs ($35,300 × 4)	$ 141,200.00
Less: Fixed costs ($24,000 × 4)	$   96,000.00
Less: Selling & administrative ($29000 x 4)	$ 116,000.00
Less: Depreciation = $98,500 /5 x 4	$   78,800.00
Total Cost		$ (432,000.00)
Net Income		$  524,000.00
(2) The old elevator is replaced.
Sales ($239,000 × 4 years)		$  956,000.00
Less: Variable costs ($10,000 × 4)	$   40,000.00
Less: Fixed costs ($8,900 × 4)	$   35,600.00
Less: Selling & administrative ($29000 x 4)	$ 116,000.00
Less: Depreciation	$ 159,000.00
Total Cost		$ (350,600.00)
Operating Income		$  605,400.00
Less: Loss on old elevator		$   (53,100.00)
Net Income		$  552,300.00
c.Using incremental analysis, determine if the old elevator should be replaced
	Retain Old Elevator	Replace old Elevator	Net Income Increase(Decrease
Variable operating costs	$ 141,200.00	$    40,000.00	$ 101,200.00
Fixed operating costs	$   96,000.00	$    35,600.00	$   60,400.00
New elevator cost		$  159,000.00	$(159,000.00)
Salvage on old elevator		$   (25,700.00)	$   25,700.00
Totals	$ 237,200.00	$  208,900.00	$   28,300.00
d)
When deciding whether to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $53,100 loss that would be experienced if we replace the old elevator with the newer rmodel is related to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in decision making.