A company is considering replacing an old piece of machinery, which cost $600,000 and has $350,000 of accumulated depreciation to date

A company is considering replacing an old piece of machinery, which cost $600,000 and has $350,000 of accumulated depreciation to date, with a new machine that costs $528,000. The old machine could be sold for $82,000. The annual variable production costs associated with the old machine are estimated to be $167,000 per year for eight years. The annual variable production costs for the new machine are estimated to be $109,000 per year for eight years.

a. Prepare a differential analysis dated September 11, 2014, to determine whether to continue with (Alternative 1) or replace (Alternative 2) the old machine.

b. What is the sunk cost in this situation?


Answer:

a. Differential Analysis 
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) 
September 11, 2014 
 Continue 
with Old 
Machine 
(Alternative 1) 
Replace 
Old 
Machine 
(Alternative 2) 
Differential 
on Income 
(Alternative 2) 
Revenues:    
Proceeds from sale of old    
machine $ 0 $ 82,000 $ 82,000 
Costs:    
Purchase price 0 –528,000 –528,000 
Variable production costs (8 years) –1,336,0001

–872,0002

Income (Loss) –$1,336,000 –$1,318,000 $ 18,000 
    
$167,000 × 8 years 
$109,000 × 8 years 
The company should replace the old machine. 
b. The sunk cost is the $250,000 book value ($600,000 cost less $350,000 accumulated 
depreciation) of the present machine. The original cost and accumulated depreciation 
were incurred in the past and are irrelevant to the decision to replace the machine.