Question

Sprockets Corporation is thinking about replacing a piece of manufacturing equipment with a remaining useful life of six years. The book value of the equipment is $55,000, and the machine could be sold in its current condition for $29,000. The new machine would cost $125,000 and would have a salvage value of $25,000 at the end of its six-year useful life. With the new machine, Sprocket’s annual variable manufacturing costs would drop from $78,000 to $65,000. Given these figures, Sprockets will ________ over the next six years if it purchases the new machine.

A : decrease its net income by $47,000
B : increase its net income by $7,000
C : decrease its net income by $18,000
D : increase its net income by $22,000

Answer 1

B) increase its net income by $7,000

Step-by-step explanation:

If Sprockets replaces the equipment:

• salvage value of old equipment $29,000
• new depreciation costs ($125,000 - $25,000 = $100,000)
• money saved using new equipment $13,000 per year x 6 years = $78,000

total benefit of buying new equipment = $29,000 - $100,000 + $78,000 = $7,000