Question

Last year (2016), Richter Condos installed a mechanized elevator for its tenants.
The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator’s speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked the company’s accountant to provide him with cost data on the company’s elevator. This information is presented below.

	Old Elevator	New Elevator
Purchase price	$120,000	$160,000
Estimated salvage value	0	0
Estimated useful life (years)	5	4
Depreciation method	Straight line	Straight line
Annual operating costs other than depreciation
Variable	$35,000	$10,000
Fixed	23,000	8,500

Annual revenues are $240,000, and selling and administrative expenses are $29,000,
regardless of which elevator is used. If the old elevator is replaced now, at the beginning of 2017, Richter Condos will be able to sell it for $25,000.

Instructions:

a. Determine any gain or loss if the old elevator is replaced.

b. Prepare a 4-year summerized income statement for each of the following assumptions:

1. The old elevator is raetained.

2. The old elevator is replaced.

c. Using incremental analysis, determine if the old elevator should be replaced.

Answer 1

a. Determine the gain or loss, if the old elevator is replaced Particulars Amount(S) 120,000 Purchase price (A) Life (B) Depreciation for one year (C-A B) Book value after one year (D A Sale value of elevator (E) 24,000 96,000 25,000 71,000 Loss on sale of old elevator (D-E) Hence, the loss on sale of old elevator is |S71,000 4-year summarized income statement, if old elevator is retained Amount(S) Amount(S) 960,000 Particulars Revenue (A) Less Total costs: Variable costs (35,000x4) Fixed costs (23.000x4 Selling and administrative (29,000x4 Depreciation (24,000x4) Total cost (B) Net income (A-B) 140,000 92,000 116,000 96,000 444,000 516,000 4-year summarized income statement, if old elevator is replaced

Particulars Amount(S) Amount(S) 960,000 Revenue (A) Less Total costs: Variable costs (10,000x4) Fixed costs (8,500x4) Selling and administrative (29,000x4 40,000 34,000 116,000 160,000 reciation Total cost (B) 350,000 610,000 71,000 539,000 erating income (C-A-B Less: Loss on sale of old elevator(D) Net income (C-D) Note: The life of new elevator is 4 years. Hence, the entire cost of S160,000 is depreciated for four years C. Incremental analysis to determine, if the old elevator should be replaced Net Retain(A) Replace(B) income/(loss) Particulars (A-B) Variacle operating costs Fixed o New elevator cost Salvage on old elevator 140,000 92,000 100,000 58,000 160,000) 25,000 23,000 40,000 34,000 160,000 (25,000) 232,000209,000 ating costs Total As per the incremental analysis, by replacing the old elevator the net income increases by $23,000 Hence, old elevator should be replaced