Question

Kim Inc. is considering the replacement of a piece of equipment with a newer model. The following data has been collected: Old Equipment New Equipment Purchase price $262,500 $450,000 Accumulated depreciation 95,000 - 0 - Annual operating costs 300,000 245,000 If the old equipment is replaced now, it can be sold for $92,500. Both the old equipment's remaining useful life and the new equipment's useful life is 10 years. The net advantage (disadvantage) of replacing the old equipment with the new equipment is

Answer 1

Answer:

Kim Inc.

The net advantage (disadvantage) of replacing the old equipment with the new equipment is:

= $7,500.

Explanation:

a) Data and Calculations:

                                                     Old Equipment     New Equipment  

Purchase price                                 $262,500              $450,000

Accumulated depreciation                  95,000               0  

Annual operating costs                     300,000                245,000

Total operating costs for 10 years 3,000,000             2,450,000

Salvage                                                 92,500             0

Total incremental cost                 $2,907,500           $2,900,000

b) The net advantage obtained by Kim for replacing the old equipment with the new equipment is $7,500 ($2,907,500 - $2,900,000).  Note that the purchase price of the old equipment with its accumulated depreciation are not relevant costs.  This case is worked out without taking into account the time value of money.  Assuming that the present value of the cash flows was computed, a different result and conclusion would be reached.