Question

1. Purinton Company is considering replacing a metal cutting machine with a newer model.

Here are the data the management accountant prepares for the existing (old) machine and the replacement (new) machine:

	Old	New
Original Cost	$1,000,000	$600,000
Useful Life	5 Years	2 Years
Current Age	3 Years	0 Years
Remaining Useful Life	2 Years	2 Years
Accumulated Depreciation	$600,000	n.a.
Current Disposal Value	$40,000	n.a.
Terminal Disposal Value	$0	$0
Annual Operating Costs	$800,000	$460,000
Annual Revenues	$1,100,000	$1,100,000

Purinton Corporation uses straight-line depreciation. Ignore the time value of money and income taxes. Should Purinton replace its old machine?

Answer 1

Option 1 Continue with Old Machinery Total Revenue 1100000 x2 less: Annual Operating Costs 800000 x2 less: Remaining Depreciation (Sunk cost) Net Income 22,00,000 (16,00,000) (4,00,000) 2,00,000 Option 2 Replace old Machinery (Install new) 1100000 x2 Total Revenue add: Disposal of Old Machine less: Total Operating Costs less: Purchase of new Machinery Net Income 460000 x2 22,00,000 40,000 (9,20,000) (6,00,000) 7,20,000 As the Net Income in Option 2 is higher than the Option 1, machine should be replaced If Sunk cost is not to be taken into account, then Net income from Option 1 would be $200,000+ $400,000 = $600,000. Therefore in that scenario also Option 2 - Replace old machiney is to be chosen

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