# Sell or process further analysis firm as a whole

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Sell or process further analysis Firm as a Whole Alternative One (1) Alternative Two (2) X Y Total X YA Total Differential effect Revenues 90000 30000 120000 90000 80000 170000 50000 Joint costs 100000 - 100000 - Separable costs - 40000 40000 40000 Total costs 100000 140000 40000 Income effects 20000 30000 10000
Learning Objective 6 Equipment Replacement
Equipment Replacement The book value of equipment is not a relevant consideration in deciding whether to replace the equipment. Because it is a past, not a future cost
Equipment Replacement Four commonly Encountered items in deciding whether replace or keep existing items Book value of old equipment Disposal value of old equipment Gain or loss on disposal Cost of new equipment
Relevance of Equipment Data The book value of old equipment is irrelevant because it is a past (historical) cost. Therefore, depreciation on old equipment is irrelevant. The disposal value of old equipment is relevant because it is an expected future inflow that usually differs among alternatives. The cost of new equipment is relevant because it is an expected future outflow that will differ among alternatives.
Relevance of Equipment Data Gain or Loss on Disposal This is the difference between book value and disposal value. It is a meaningless combination of irrelevant (book value) and relevant items (disposal value). It is best to think of each separately.
Equipment Replacement Depreciation is the periodic allocation of the cost of equipment. Accumulated depreciation is the sum of all depreciation charged to past periods. The equipment’s book value (or net book value) is the original cost less accumulated depreciation. A sunk cost is a cost already incurred and is irrelevant to the decision-making process.
Equipment Replacement Suppose a \$10,000 machine with a 10-year life span has depreciation of \$1,000 per year. What is the book value at the end of 6 years? Original cost \$10,000 Accumulated depreciation (6 × \$1,000) 6,000 Book value \$ 4,000
Keep or Replace the Old Machine? Old Machine Replacement Machine Original cost \$ 10,000 \$ 8,000 Useful life in years 10 4 Current age in years 6 0 Useful life remaining in years 4 4 Accumulated depreciation \$ 6,000 0 Book Value \$ 4,000 N/A Disposal value (in cash) now \$ 2,500 N/A Disposal value in 4 years 0 0 Annual cash operating costs \$ 5,000 \$3,000
Cost Comparison Four Years Together Keep Replace Difference Cash operating costs \$20,000 \$12,000 \$8,000 Old equipment (book value): Depreciation, or 4,000 - - Lump-sum write-off - 4,000 - Disposal value - (2,500) 2,500 New Machine Acquisition Cost - 8,000 (8,000) Total Cost \$ 24,000 \$21,000 \$ 2,500
Keep or Replace the Old Machine? The advantage of replacement is \$2,500 for the 4 years together In a formal income statement, these two items would be combined as “loss on disposal” of \$4,000 - \$2,500 = \$1,500 In a formal income statement, written off as straight line depreciation \$8000 / 4 = \$2,000 for each of 4 years The relevant items : Operating cost, disposal value and acquisition cost give replacement a net advantage of \$2,500
Learning Objective 7 Irrelevant or Misspecified Costs
Irrelevant or Misspecified Costs The ability to recognize irrelevant costs is important to decision makers.
Irrelevant or Misspecified Costs

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• Fall '19
• Limited Resources, Nantucket Nectars, Misspecified Costs

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