Mead Company is considering the replacement of some of its manufacturing equipme
ID: 2511337 • Letter: M
Question
Mead Company is considering the replacement of some of its manufacturing equipment. Information regarding the existing equipment and the potential replacement equipment follows:
*The amounts shown for operating expenses are the cumulative total of all such expected expenses to be incurred over the useful life of the equipment.
Required
Calculate the total relevant cost of existing equipment and the potential replacement equipments. Should the equipment be replaced?
Total cost new?
Total cost old?
Existing Equipment Replacement Equipment Cost $ 300,000 Cost $ 250,000 Operating expenses* 240,000 Operating expenses* 160,000 Salvage value 40,000 Salvage value 40,000 Market value 120,000 Useful life 8 years Book value 90,000 Remaining useful life 8 yearsExplanation / Answer
Existing equipment
Replacement equipment
Total relevant cost
$320000
$370000
So on the basis of relevant costs of both equipment, it is clear that relevant cost of existing equipment is less than replacement equipment. Thus equipment should not be replaced.
Explanation & Working Note;
Total relevant cost of existing equipment will be calculated with the help of opportunity cost and operating expenses. Hence let’s calculate these one by one;
Opportunity cost of exiting equipment will be calculated as follow;
Market value of existing equipment
$120000
Less: Salvage value of existing equipment
($40000)
Opportunity cost
$80000
Operating expenses of existing equipment are given = $240000
Thus, Total relevant cost of existing equipment = Opportunity cost + Operating expenses
($80000 + $240000) = $320000
Total relevant cost of potential replacement equipment will be calculated with the help of adjusted purchase price and operating expenses. Hence let’s calculate these one by one;
Adjusted purchase price of potential replacement equipment will be calculated as follow;
Cost of replacement equipment
$250000
Less: Salvage value of replacement equipment
($40000)
Adjusted purchase price
$210000
Operating expenses of replacement equipment are given = $160000
Thus, Total relevant cost of replacement equipment = Adjusted purchase price + Operating expenses
($210000 + $160000) = $370000
Existing equipment
Replacement equipment
Total relevant cost
$320000
$370000