Question

A company purchased manufacturing equipment 5 years ago for $50,000. Accumulated depreciation is currently $45,000 and the remaining useful life is 3 years. The equipment incurs annual operating costs of $30,000. The company is considering replacing the equipment. The new equipment will cost $75,000, have a useful life of 3 years, and is more efficient and, therefore, only costs $10,000 to operate each year. The vendor is willing to accept the old equipment with a trade-in allowance of $10,000. The company should:

Multiple choice question.

A. keep the old equipment because the total net increase in income will be $5,000

B. replace the old equipment because the total net increase in income will be $5,000

C. keep the old equipment because the total net decrease in income will be $5,000 if they purchase the new equipment

D. replace the old equipment because the total net decrease in income will be $5,000

Answer 1

The company should keep the old equipment because the total operating costs over the next three years are $5,000 less than the total cost of purchasing and operating the new equipment, which includes a trade-in allowance.

Step-by-step explanation:

The question involves comparing the costs and benefits of keeping old manufacturing equipment versus purchasing new equipment by calculating the net change in income for a company. To determine the best financial decision, we will compare the total costs over the remaining 3-year period for both the old and new equipment.

For the old equipment, the costs would be:

• Annual operating costs: 3 years × $30,000 = $90,000

For the new equipment, the costs would be:

• Purchase price: $75,000
• Annual operating costs: 3 years × $10,000 = $30,000
• Less trade-in allowance for old equipment: $10,000

The total cost for the new equipment, therefore, is $75,000 + $30,000 - $10,000 = $95,000.

The old equipment will cost a total of $90,000 to operate for 3 more years, whereas the new equipment will have a total cost of $95,000, taking into account the trade-in allowance. As the new equipment costs $5,000 more over the 3-year period, the answer is Option A: keep the old equipment because the total net increase in income will be $5,000 if they continue to use the old equipment.