Question

1. Maxwell Company has an opportunity to acquire a new machine to replace one of its current machines. The new machine would cost $90,000, have a five-year life, and an estimated salvage value of $10,000. Variable operating costs of the new machine are $100,000 per year. The current machine was purchased for $75,000 and has an accumulated depreciation of $25,000 with a remaining useful life of five years. If the new machine is purchased, the current machine will be sold for $5,000, but if the new machine is not purchased the current machine will be worthless at the end of five years. The current machine incurs variable operating costs of $125,000 per year. What is the incremental profit (loss) associated with purchasing the new machine?
2. Colson Manufacturing Company produces a variety of products. Sales of “Zlone,” one of its products, total $400,000 per year; variable costs are $260,000 per year and separable fixed costs are $80,000 per year. Joint costs allocated to Zlone total $100,000. Company management is considering dropping Zlone, although it has no alternative use for the facilities. Prepare an incremental analysis to determine if the product should be dropped.

Answer 1

Calculation of incremental profit (loss) associated with purchasing the new machine

                                Particulars                                                                            Amount in ($)

Incremental cost of new machinery ($90,000 - $5,000)      85,000

Savings in variable operating cost ($125,000 - 100,000) - 25,000

Incremental Depreciation ($16,000 - $10,000)                                                            6,000

Incremental Salvage Value ($10,000 - 0)                                                                   - 10,000

Net Incremental Loss                                                                                               56,000

Incremental Analysis to determine if the product should be dropped

Sales revenue from Sale of "Zlone" product                                                            $400,000

Less : Variable Cost                                                                                            $260,000

Less : Joint cost Allocated                                                                                   $100,000

          Contribution                                                                                              $40,000

Thus, if product "Zlone" is discontinued then Maxwell company will lose contribution of $40,000

which is the opportunity cost of Maxwell company of discontinuing product "Zlone"

Note : While making incremental analysis sunk costs which are fixed in nature or the costs which have already been incurred will not be taken into account.