Question

6-40 Replacement of Old Equipment

Three years ago, the Oak Street TCBY brought a frozen yogurt machine for $11,200. A salesman has just suggested to the TCBY manager that she replace the machine with a new $13,500 machine. The manager has gathered the following data:

	Old Machine	New Machine
Original Cost	$11,200	$13,500
Useful Life in years	8	5
Current age in years	3	0
Useful life remaining in years	5	5
Accumulated depreciation	$ 4,200	Not acquired yet
Book value	$ 7,000	Not acquired yet
Disposal value (in cash) now	$ 2,500	Not acquired yet
Disposal value in 5 years	0	0
Annual cash operating cost	$ 5,300	$ 2,700

1. Compute the difference in total costs over the next 5 years under both alternatives, that is, keeping the original machine or replacing in with the new machine. Ignore taxes.

2. Suppose the Oak Street TCBY manager replaces the original machine. Compute the “loss on disposal” of the original machine. How does this amount offset your computation in number 1? Explain

xplain

Answer 1

(1). According to the scenario, computation of the given data are as follows:

Cash operating cost = Cash ope. cost Annual * Years

So, Cash ope. cost for old machine = $5,300 * 5 years = $26,500

and, Cash ope. cost for new machine = $2,700 * 5 years = $13,500

Description	Old machine	New machine	Difference
Cash operating cost	$26,500	$13,500	$13,000
depreciation value, periodic	$7,000
lump-sum writeoff		$7,000
Disposable value (old)		($2,500)	$2,500
Cost of acquisition (New)		$13,500	($13,500)
Total cost	$33,500	$31,500	$2,000

So, Replacing with new machine is better option because it saves $2,000.

2. Loss on disposal can be calculated as follows:

Loss on disposal = (Book Value - Disposal Value)

By putting the value, we get

Loss on disposal = ( $7,000 - $2,500)

= $4,500

As, this is irrelevant cost, lump-sum write off and disposal value should be kept separate and it also does not affect cost computation.