Question

Machine Replacement Decision

A company is considering replacing an old piece of machinery, which cost $597,100 and has $348,000 of accumulated depreciation to date, with a new machine that has a purchase price of $484,500. The old machine could be sold for $64,000. The annual variable production costs associated with the old machine are estimated to be $156,000 per year for eight years. The annual variable production costs for the new machine are estimated to be $100,100 per year for eight years.

a.1 Prepare a differential analysis dated May 29 to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine. If an amount is zero, enter "0". If required, use a minus sign to indicate a loss.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 29
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effects (Alternative 2)
Revenues:
Proceeds from sale of old machine	$	$	$
Costs:
Purchase price
Variable productions costs (8 years)
Profit (Loss)	$	$	$

a.2 Determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine.

b. What is the sunk cost in this situation?

The sunk cost is $.

Answer 1

a1.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May-29
	Continue	Replace
	with Old	Old	Differential
	Machine	Machine	Effects
	(Alternative 1)	(Alternative 2)	(Alternative 2)
Revenues:
Proceeds from sale of old machine	0	64,000	64,000
Costs:
Purchase price	0	-484,500	-484,500
Variable productions costs (8 years)	-1,248,000	-800,800	-447,200
Profit (Loss)	-1,248,000	-1,221,300	26,700

Annual variable production cost of old machine = $156,000

Annual variable production cost of new machine = $100,100

Variable production cost of old machine for 8 year = Annual variable production cost of old machine x 8

= 156,000 x 8

= $1,248,000

Variable production cost of new machine for 8 year = Annual variable production cost of new machine x 8

= 100,100 x 8

= $800,800

a.2

Replace old machine.

b.

Sunk cost will be equal to book value of old machine.

cost price of old machine = $597,100

Accumulated depreciation = $348,000

Book value of old machine = cost price of old machine- Accumulated depreciation

= 597,100-348,000

= $249,100

The sunk cost is $249,100.

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