Question

Problem 12-4 Last year (2016), Pronghorn 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. Old Elevator New Elevator Purchase price $104,500 $161,000 Estimated salvage value 0 0 Estimated useful life 5 years 4 years Depreciation method Straight-line Straight-line Annual operating costs other than depreciation: Variable $35,600 $11,000 Fixed 23,200 9,000 Annual revenues are $239,000, 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 2017, Pronghorn Condos will be able to sell it for $24,700. Determine any gain or loss if the old elevator is replaced. $ Link to Text Prepare a 4-year summarized income statement for each of the following assumptions: (1) The old elevator is retained. Retain Old Elevator Revenues $ Less costs: Variable costs $ Fixed costs Selling & administrative Depreciation Net income $ (2) The old elevator is replaced. Replace Old Elevator Revenues $ Less costs: Variable costs $ Fixed costs Selling & administrative Depreciation Operating income Less: Loss on old elevator Net income $ Link to Text Using incremental analysis, determine if the old elevator should be replaced. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Retain Old Elevator Replace Old Elevator Net Income Increase (Decrease) Variable operating costs $ $ $ Fixed operating costs New elevator cost Salvage on old elevator Totals $ $ $

Answer 1

Solution

Pronghorn Corp

1. Gain or loss if old elevator is replaced:

Cost = $104,500

Useful life = 5 years

Annual depreciation= $104,500/5 = $20,900

Accumulated depreciation till date = $20,900

Book value= $83,600

Sale value = $24,700

Loss on sale = $58,900

1. Summarized income statement assuming the old elevator is retained:

Retain old elevator:
Revenues	$	$956,000	(4 x $239,000)
Less: Costs
Variable costs	$142,400		(4 x 35,600)
Fixed costs	$92,800		(4 x 23,200)
Selling and administrative costs	$116,000		(4 x 29,000)
Depreciation	$83,600		(4 x 20,900)
Total costs		$434,800
Net Income		$521,200

Assuming the old elevator is replaced:

4-Year Summarized Income Statement
Replace old elevator:
Revenues	$	$956,000	(4 x $239,000)
Less: Costs
Variable costs	$44,000		(4 x 11,000)
Fixed costs	$36,000		(4 x 9,000)
Selling and administrative costs	$116,000		(4 x 29,000)
Depreciation	$161,000		(4 x 40,250)
Total costs		$357,000
Operating income		$599,000
Less: Loss on sale of old elevator		$58,900
Net Income		$540,100

Incremental Analysis to determine if old elevator should be replaced:

	Retain Old Elevator	Replace Old Elevator	Net Income Increase (Decrease)
Variable operating costs	$142,400	$44,000	$98,400
Fixed operating costs	$92,800	$36,000	$56,800
New elevator cost		$161,000	($161,000)
sale proceeds old elevator		($24,700)	$24,700
Totals	$235,200	$216,300	$18,900