Question

A company is considering replacing an old piece of machinery, which cost $597,600 and has $351,400 of accumulated depreciation to date, with a new machine that has a purchase price of $483,600. The old machine could be sold for $64,900. The annual variable production costs associated with the old machine are estimated to be $157,400 per year for eight years. The annual variable production costs for the new machine are estimated to be $99,300 per year for eight years.

Required:
a. Prepare a differential analysis dated April 29 to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine.
b. What is the sunk cost in this situation?

Answer 1

Differential Analysis : April 29

Continue old machine Replace old Differential

machine effect on income

Revenue : (Alternative 1) (Alternative 2) (Alternative 2)

Proceeds from

sale of old machine 0 64,900 64,900

Cost :

Purchase price 0 -483,600 -483,600

Variable

manufacturing cost -1,259,200 - 794,400 464800

Total cost -1,259,200 -1278000 -18800

Income (loss) -1,259,200 -12131000 46100

So the company should replace the sold machine.

The sunk cost is = 597,000 - 351,400

= $245,600