Question

U P25-4B n e hel income from operations (5135.000) with the total income from operations without Division IV. Last year (2011), Boume Company installed new factory equipment. The owner of the company. Jason Boume, recently returned from an industry equipment exhibition where he watched computerized equipment demonstrated. He was impressed with the equipment's speed and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new equipment. In addition, he asked the company's accountant to provide him with cost data on the company's equipment. This information is presented below. 0 Old Equipment New Equipment Purchase price $210,000 $270,000 Estimated salvage value Estimated useful life 6 years 5 years Depreciation method Straight-line Straight-line Annual operating cost other than depreciation: Variable $50,000 $15,000 Fixed 30,000 8,000 Annual revenues are $360,000, and selling and administrative expenses are $45,000. regardless of which equipment is used. If the old equipment is replaced now, at the beginning of 2012. Bourne Company will be able to sell it for $38,000. Instructions(a) Determine any gain or loss if the old equipment is replaced. (b) Prepare a 5-year summarized income statement for each of the following assumptions: 1. The old equipment is retained. 2. The old equipment is replaced. (C) Using incremental analysis, determine if the old equipment should be replaced. (d) Write a memo to Jason Bourne explaining why any gain or loss should be ignored in the decision to replace the old equipment.

Answer 1

a. Determine any gain or loss if the old equipment  is replaced.
Cost	$           210,000.00
Accumulated depreciation (210,000/6)	$            (35,000.00)
Book Value	$           175,000.00
Sales proceeds	$            (38,000.00)
Loss on sale	$           137,000.00
b.Prepare a 5-year summarized income statement for each of the following assumptions
(1) The old equipmentr is retained.
Sales ($360,000 × 5years)		$  1,800,000.00
Less: Variable costs ($50000 × 5)	$           250,000.00
Less: Fixed costs ($30,000 × 5)	$           150,000.00
Less: Selling & administrative ($45000 x 5)	$           225,000.00
Less: Depreciation = $210,000 /6 x 5	$           175,000.00
Total Cost		$    (800,000.00)
Net Income		$  1,000,000.00
(2) The old equipment is replaced.
Sales ($360,000 × 5years)		$  1,800,000.00
Less: Variable costs ($15,000 × 5)	$             75,000.00
Less: Fixed costs ($8,000 × 5)	$             40,000.00
Less: Selling & administrative ($45000 x 5)	$           225,000.00
Less: Depreciation	$           270,000.00
Total Cost		$    (610,000.00)
Operating Income		$  1,190,000.00
Less: Loss on old elevator		$    (137,000.00)
Net Income		$  1,053,000.00
c.Using incremental analysis, determine if the old equipmentr should be replaced
	Retain Old Elevator	Replace old Elevator	Net Income Increase(Decrease
Variable operating costs	$           250,000.00	$       75,000.00	$             175,000.00
Fixed operating costs	$           150,000.00	$       40,000.00	$             110,000.00
New elevator cost		$     270,000.00	$            (270,000.00)
Salvage on old elevator		$      (38,000.00)	$               38,000.00
Totals	$           400,000.00	$     347,000.00	$               53,000.00
d)
When deciding whether to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $137,000 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.