Last year (2013), Richter Condos installed a mechanized elevator for its tenants

Question

Last year (2013), Richter Condos installed a mechanized elevator for its tenants. The owner of the company, Ron Richter, recently returned from an industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed with the elevator's speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked the company's accountant to provide him with cost data on the company's elevator: This information is presented below. Annual revenues are $240,000, and selling and administrative expenses are $29,000, regardless of which elevator is used. If the old elevator is replaced now, at the beginning of 2014, Richter Condos will be able to sell it for $25,000. Instructions Determine any gain or loss if the old elevator is replaced. Prepare a 4-year summarized income statement for each of the following assumptions: The old elevator is retained. The old elevator is replaced. Using incremental analysis, determine if the old elevator should be replaced. Write a memo to Ron Richter explaining why any gain or loss should be ignored in the decision to replace the old elevator.

Explanation / Answer

a. The book value of the old elevator = Cost - Accumulated depreciation = $ 120,000 - $ 24,000 = $ 96,000

Gain or (loss) if the old elevator is replaced = $ 25,000 - $ 96,000 = $ (71,000)

b. Summarized income statement:

1. The old elevator is retained:

2. The old elevator is replaced:

c. The old elevator should be replaced, since there would be incremental profit of $ ( 635,000 - 516,000 ) = $ 119,000

d. Any gain or loss on sale of the old elevator should be ignored in the decision to replace the old elevator, because, the book value of the old elevator, being a sunk cost, is not relevant to decision making.

2014 2015 2016 2017 Total Sales 240,000 240,000 240,000 240,000 Selling and administrative expenses 29,000 29,000 29,000 29,000 Elevator operating costs 58,000 58,000 58,000 58,000 Depreciation expense of elevator 24,000 24,000 24,000 24,000 Total costs 111,000 111,000 111,000 111,000 Net operating income 129,000 129,000 129,000 129,000 516,000

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