Question

Mambo Company is considering a new machine for its production plant to replace an old machine that originally cost $14,000 and has $11,000 of accumulated depreciation. The new machine can be purchased at a cash cost of $20,000, but the distributor of the new machine has offered to take the old machine in as a trade-in, thereby reducing the cost of the new machine to $18,000.

Suppose that Mambo had the opportunity to sell the old machine to a friend at another company for $2,500 but chose instead to trade the machine in on the new machine, to avoid the risk of the friend not being satisfied with the old machine.
Now suppose that the product that the new machine makes is expected to be produced for only three more years. The old machine is expected to last for three additional years, but the new machine will save labor cost of $3,000 per year over the next three years. At the end of the three years, both machines would be obsolete and would have no expected salvage value.
Assuming a differential analysis approach, determine the total cost associated with keeping the old machine, the total cost of buying the new machine, and the differential cost of buying the new machine.

Total cost of keeping Total cost of buying Differential cost of
old machine new machine new machine
a. $14,000 $20,000 $(6,000)
b. $14,000 $18,000 $(4,000)
c. $3,000 $11,500 $(8,500)
d. $0 $9,500 $(9,500)

Answer 1

Option (c) : $3,000 $11,500 $(8,500)

Explanation :

As per the data given in the question,

Original price of the old machine is $14,000 and it has $11,000 accumulated depreciation.

which means value of old machine = $14,000 - $11,000 = $3,000 which is the cost of having old machine.

New machine can be purchased at $20,000 but distributor of new machine offered to take old machine in as a trade-in, so cost of new machine = $18,000. it means effective cost of new machine = $18,000 simultaneously Mambo had opportunity to sell machine in $2,500

So cost of new machine is

= $18,000 + $ 2,500

= $20,500

Since, New machine will save labor cost = $3,000 per year

Therefore effective cost of new machine = $20,500 - ($3,000 × 3) = $11,500

Hence net incremental cost of buying new machine = $3,000 - $11,500

= $(8,500)