Question

Management of Plascencia Corporation is considering whether to purchase a new model 370 machine costing $502,000 or a new model 220 machine costing $443,000 to replace a machine that was purchased 11 years ago for $470,000. The old machine was used to make product I43L until it broke down last week. Unfortunately, the old machine cannot be repaired. Management has decided to buy the new model 220 machine. It has less capacity than the new model 370 machine, but its capacity is sufficient to continue making product I43L. Management also considered, but rejected, the alternative of simply dropping product I43L. If that were done, instead of investing $443,000 in the new machine, the money could be invested in a project that would return a total of $487,000. In deciding to buy the model 220 machine rather than the model 370 machine, the differential cost was:

Answer 1

Differential cost is the difference between costs of two alternatives. The method to identify differential cost is to compute variable and fixed costs of various alternatives. There are two alternatives in the given case, Model 370 and Model 220.

Cost of purchase of Model 370 = $ 502,000

Cost of purchase of Model 220 = $ 443,000

Hence, differential cost = $ 59,000