Compute the increase or decrease in total income over the five-year period if the company chooses to overhaul its existing machinery. 4) What is your recommendation for this decision?
What will be an ideal response?
1) Sunk costs include the original cost and accumulated depreciation (i.e., book value) of the existing machinery.
2) Increase or decrease in income if new machine is purchased:
Cost savings: ($5,000 − $1,000) × 5 | $ | 20,000 | |
Current market value | 1,500 | ||
Cost of new equipment | (56,000 | ) | |
Decrease in income | $ | (34,500 | ) |
3) Increase or decrease in income if machine is overhauled:
Cost savings: ($5,000 − $2,000) × 5 | $ | 15,000 | |
Cost of overhaul | (12,000 | ) | |
Increase in income | $ | 3,000 |
4) The existing machine should be overhauled.