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

Solution :

                      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