Final answer:
The salvage value is relevant in an incremental analysis for a retain-or-replace decision as it represents potential income, affecting the cost and benefit evaluation. Conversely, the book value is a sunk cost and therefore not relevant, since it does not impact future cash flows.
Step-by-step explanation:
When conducting an incremental analysis for the retain-or-replace decision, the relevance of the salvage value and the book value of an existing machine must be considered. The correct answer to the student's question is: d) The salvage value of the machine is relevant to the decision-making process, but the book value is not relevant because the salvage value represents income and the book value represents sunk costs.
The book value is a historical figure that does not impact future cash flows and thus can be viewed as a sunk cost—costs that have already been incurred and cannot be recovered. As such, book value should not influence the decision-making process. In contrast, the salvage value is the amount that could be received from selling the machine at the end of its useful life. This is a future cash inflow and should be included in the incremental analysis, as it represents potential income that affects the cost and benefit evaluation of a decision.
Employing a cost/benefit analysis involves comparing what one will sacrifice versus what one will gain. This includes weighing marginal costs against marginal benefits. Since the salvage value can alter the marginal benefits of a replacement decision, it is crucial to include it in the analysis, whereas the book value would not affect marginal benefits since it is a sunk cost.