Last year (2011), Bourne Company installed new factory equipment. The owner of the company, Jason Bourne, recently returned from an industry equipment exhibition where he watched computerized equipment demonstrated. He was impressed with the equipment's speed and cost efficiency. Upon returning from the exhibition, he asked his purchasing agent to collect price and operating cost data on the new equipment. In addition, he asked the company's accountant to provide him with cost data on the company's equipment. This information is presented below.
Old Equipment New Equipment
Purchase price $210,000 $270,000
Estimated salvage value 0 0
Estimated useful life 6years 5years
Depreciation method Straight-line Straight-line
Annual operating cost other than depreciation:
Variable $50,000 $15,000
Fixed 30,000 8,000
Annual revenues are $360,000, and selling and administrative expenses are $45,000, regardless of which equipment is used. If the old equipment is replaced now, at the beginning of2012, Bourne Company will be able to sell it for $38,000.
Instructions: (a) Determine any gain or loss if the old equipment is replaced.
(b) Prepare a 5-year summarized income statement for each of the following assumptions:
1. The old equipment is retained.
2. The old equipment is replaced.
(c) Using incremental analysis, determine if the old equipment should be replaced.
(d) Write a memo to Jason Bourne explaining why any gain or loss should be ignored in the decision to replace the old equipment.