Question

The Nanjing Company produces and sells 5,000 of baby carriages per year at a selling price of $100 each. Its current production equipment was purchased two years ago for $500,000. The equipment is being depreciated on the straight-line basis with a 5-year useful life and zero salvage value. The emergence of a new technology has led Nanjing to consider either upgrading or replacing the production equipment. The following table presents data for the two alternatives: Upgrade Replace One-time costs $300,000 $450,000 Current disposal value $60,000 N/A Variable manufacturing costs per carriage $30 $20 Remaining useful life of equipment (year) 3 3 Terminal disposal value of equipment at end of useful life $0 $0 All equipment costs will continue to be depreciated on a straight-line basis. For simplicity, ignore income taxes and the time value of money. 10. Which costs would not be relevant in determining if the company should upgrade or replace the equipment? A) $450,000 B) $60,000 C) $300,000 D) $500,000 11. Should the company upgrade or replace the equipment? A) Replace because the total relevant costs for replacing the equipment is $75,000 less than the total relevant costs for the upgrade option. B) Replace because the total relevant costs for replacing the equipment is $60,000 less than the total relevant costs for the upgrade option. C) Upgrade because the total relevant costs for upgrading the equipment is $60,000 less than the total relevant costs for the replace option. D) Upgrade because the total relevant costs for upgrading the equipment is $75,000 less than the total relevant costs for the replace option. 12. For what annual production and sales quantity would total costs for upgrading equal the total costs for replacing? A) 3,000 B) 7,000 C) 5,000 D) 2,000

Answer 1

Given:

Baby carriages sold per year = 5,000 units

Upgrade One-time costs = $300,000

Replace One-time costs = $450,000

Current disposal value = $60,000

Remaining useful life of equipment for both options = 3 years

Terminal disposal value of equipment at end of useful life for both options = $0

Variable manufacturing costs per carriage for upgrade option = $30

Variable manufacturing costs per carriage for replace option = $20

Income Tax and time value of money to be ignored.

Question 10 : Which costs would not be relevant in determining if the company should upgrade or replace the equipment?

Correct answer is :

D) $500,000

Here the relevant costs to be considered for decision are:

Upgrade One-time costs = $300,000

Replace One-time costs = $450,000

Current disposal value = $60,000 and

incremental variable cost over 3 years = 5,000 * 3 * (30 - 20) = $150,000

11. Should the company upgrade or replace the equipment?

Correct answer is :

B) Replace because the total relevant costs for replacing the equipment is $60,000 less than the total relevant costs for the upgrade option

Relevant costs for upgrade option = Upgrade cost + Incremental variable costs over useful life

$300,000 + $150,000 = $450,000

Relevant costs for replace option = Replacement cost - Current disposal value = $450,000 - $ 60,000 = $390,000

As such relevant cost for replace option is lesser by = $450,000 - $390,000 = $60,000

12. For what annual production and sales quantity would total costs for upgrading equal the total costs for replacing?

Correct answer is:

A) 3,000​

Current relevant cost for Replacement = $390,000

Without considering variable costs, the relevant cost for upgrade option = $300,000

Difference between above two = $390,000 - $300,000 = $90,000

Incremental variable cost per carriage (for upgrade option) = $30 - $20 = $10 per carriage

Hence, annual production and sales quantity that would equalize total costs for upgrading with the total costs for replacing = $90,000 / ($10 * 3 years) = 3,000 units