Question

Johnson Enterprises uses a computer to handle its sales invoices. Lately, business has been so good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the volume of sales invoices. Management is considering updating its computer with a faster model that would eliminate all of the overtime processing. Current Machine New Machine Original purchase cost $14,700 $25,500 Accumulated depreciation $6,500 _ Estimated annual operating costs $24,900 $19,800 Remaining useful life 5 years 5 years If sold now, the current machine would have a salvage value of $10,400. If operated for the remainder of its useful life, the current machine would have zero salvage value. The new machine is expected to have zero salvage value after 5 years. Prepare an incremental analysis to determine whether the current machine should be replaced.

Answer 1

Solution and Explanation:

The following is the incremental analysis  :

Particulars Retain machine Replace machine Net income

                                                                                    Increase / (Decrease)  

Operating costs $124500             $99000                 25500  

                                                                                      ($124500 - $99000)  

New machine costs -                 25500                  (25500)  

Salvage value (Old)                    10400                      10400  

Total                       $124500             $114100              $10400   Working notes:

Operating cost of retain machine is calculated by multiplying the estimated operating costs of old machine with the number of years. ($24900 multiply with 5 years = $124500).

Operating cost of replace machine is calculated by multiplying with the estimated operating costs of new machine with the number of years ($19800 multiply with 5 years = $99000).

CONCLUSION: using the old machine or the current machine costs higher than the purchasing of the new machine. Therefore, it is advised to replace the old machine with a new machine to save the cost.

Answer 2

The total Net income is $10400 it is recommended to replace the old machine with a new machine to preserve the cost.

Calculation of Net income:

The following is incremental analysis are :

Particulars  Retain machine         Replace machine      Net income

                                                                                   Increase / (Decrease)

                                                                                                                       

Operating costs $124500             $99000                 25500  

                                                                                     ($124500 - $99000)  

New machine costs -                25500                  (25500)  

Salvage value (Old)                   10400                      10400  

                                                                                                                         

Total                       $124500             $114100              $10400  

Working notes:

The operating cost of the retaining machine is calculated by reproducing the calculated operating costs of the old machine by the number of years. ($24900 multiply with 5 years = $124500).

The operating cost of substituting the machine is calculated by multiplying the calculated operating costs of the new machine by the number of years ($19800 multiplied by 5 years = $99000).

CONCLUSION: When using the old machine or the current machine costs are higher than the purchase of the new machine. Thus, it is advised to replace the old machine with a new machine to save the cost.

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