Chavez Company is considering purchasing new equipment or overhauling its existing equipment. The manager has gathered the following information:
Required:1) Identify the sunk costs associated with this decision.2) Compute the increase or decrease in total income over the five-year period if the company chooses to buy the new equipment.3) 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) |
| Cost savings: ($5,000 - $2,000) × 5 | $ 15,000 |
| Cost of overhaul | (12,000) |
| Increase in income | $ 3,000) |
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