Johnson Enterprises uses a computer to handle its sales invoices. Lately, busine
ID: 2560050 • Letter: J
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 Ma
chine
Original purchase cost
$15,000
$25,000
Accumulated depreciation
$
6,000
—
Estimated annual operating costs
$25,000
$20,000
Remaining useful life
5 years
5 years
If sold now, the current machine would have a salvage value of $6,000. 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.
Instructions
Should the current machine be replaced?
Explanation / Answer
Current Machine
New Machine
Original purchase cost
15,000
25,000
Accumulated depreciation
6,000
-
Estimated annual operating costs
25,000
20,000
Remaining useful life
5 years
5 years
salvage value if sold now
6,000
-
Present Value of operating cost Assuming 10% discount rate
=-PV(0.1,5,25000)
=-PV(0.1,5,20000)
94,770
75,816
Add: cost purchase of new machine
Not considered Sunk cost
25,000
Accumulated Depreciation
Not considered Sunk cost
-
Total Cost
94,770
1,00,816
Less: Salvage value on sale of old machine
-
-6,000
Net Cost
94,770
94,816
The Current machine should not be replaced since it will still lead to a saving of $46
Current Machine
New Machine
Original purchase cost
15,000
25,000
Accumulated depreciation
6,000
-
Estimated annual operating costs
25,000
20,000
Remaining useful life
5 years
5 years
salvage value if sold now
6,000
-
Present Value of operating cost Assuming 10% discount rate
=-PV(0.1,5,25000)
=-PV(0.1,5,20000)
94,770
75,816
Add: cost purchase of new machine
Not considered Sunk cost
25,000
Accumulated Depreciation
Not considered Sunk cost
-
Total Cost
94,770
1,00,816
Less: Salvage value on sale of old machine
-
-6,000
Net Cost
94,770
94,816
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