Question

Johnson Enterprises uses a computer to handle its sales invoices. Lately, business has been so good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the volume of sales invoices. Management is considering updating its computer with a faster model that would eliminate all of the overtime processing.
Current Machine New Machine
Original purchase cost $15,000 $25,000
Accumulated depreciation $6,000 ----
Estimated annual operating costs $25,000 $20,000
Remaining useful life 5 years 5 years

If sold now, the current machine would have a salvage value of $6,000. If operated for the remainder of its useful life, the current machine would have zero salvage value. The new machine is expected to have zero salvage value after 5 years. Should the current machine be replaced?

Answer 1

Answer:

The current machine should be replaced as doing that brings $6000 in benefits as shown below.

Explanation:

In order to determine which of the two options between replacing the old machine and acquiring new machine is more viable it would be appropriate to carry out an incremental cost/benefits analysis of both options:

                                                Old machine New machine  Difference

                                                     A                     B                    A-B

Operating annual costs          $125,000*      $100,000**     $25,000

New machine costs                  $0                    $25,000        -$25,000

salvage value                                                   ($,6000)            $6000

Total costs                                $125,000        $119,000            $6,000                                    

*The old machine has $125,000 ($25,000*5) estimated operating costs for five years.

**The new machine has $$100,000($20,000*5) estimated operating costs for five years

The cost of price of the old asset is not relevant as it is a sunk cost.