Johnson Enterprises uses a computer to handle its sales invoices. Lately, business has been so good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the volume of sales invoices. Management is considering updating its computer with a faster model that would eliminate all of the overtime processing.

Current Machine New Machine
Original purchase cost $15,000 $25,000
Accumulated depreciation $6,000 ----
Estimated annual operating costs $25,000 $20,000
Remaining useful life 5 years 5 years

If sold now, the current machine would have a salvage value of $6,000. If operated for the remainder of its useful life, the current machine would have zero salvage value. The new machine is expected to have zero salvage value after 5 years. Should the current machine be replaced?

In order to determine which of the two options between replacing the old machine and acquiring new machine is more viable it would be appropriate to carry out an incremental cost/benefits analysis of both options:

Old machine New machine Difference

A B A-B

Operating annual costs $125,000* $100,000** $25,000

New machine costs $0 $25,000 -$25,000

salvage value ($,6000) $6000

Total costs $125,000 $119,000 $6,000

*The old machine has $125,000 ($25,000*5) estimated operating costs for five years.

**The new machine has $100,000($20,000*5) estimated operating costs for five years

The cost of price of the old asset is not relevant as it is a sunk cost.