- May 30, 2020 at 12:22 am
Do you know why the Alternative machinery is only relevant to the adapt now decision? Surely new machinery would be needed under both options here since the new machinery is required to assemble and mould at the same time, which both options want to do? Would this $80,000 not be a non relevant cost since It is going to be paid under both options so it’s not differential between the alternatives? (see question and answer below)
S Co is considering adapting its assembly process so that products can also be moulded at the same time. The existing assembly process machinery would have to remove, either now at a dismantling cost of $100,000 and with the sale of the machinery for $800,000, or in one years time at a dismantling cost of $110,000 and with sales proceeds of $600,000. Alternative machinery would have to be leased this would cost $80,000 per annum. The existing assembly process machinery originally cost $2,000,000 when purchased seven years ago. It is being depreciated at 5% per annum on a straight line basis.
Analysing on an incremental opportunity cost basis and ignoring time value of money, which of the following is correct
A) Adapting now will produce savings of $130,000 more than adapting in one year
B) Adapting now will cost $130,000 more than adapting in one year
C) Adapting now will produce savings of $110,000 more than adapting in one year
D) Adapting now will cost $110,000 more than adapting in one year
Answer: AJune 14, 2020 at 8:07 pm
Thanks for your question – also for posting the full original question + answer ( thats really helpful).
I do see your point.
I presume you are happy that adapting now does cost 700 net… compared to costing 490 net.
-100 + 800 = 700 cost adapt now
-110 +600 = 490 cost adapting later.
So the difference between these options is $210 relevant cost savings if adapt now.
Ok so to get the $130 then the savings have deducted the cost of the lease $80K (210- 80 = 130 is total saved).
It isn’t a very well worded question – but I think if you consider all of the options then A is the only possible one which works in any sense?
My only thought is that it asks you to use opportunity cost basis.. but final question doesnt ask for RELEVANT savings.. more like total/overall savings… so it deducts the cost of the lease as shown above.
Not great – but thats all I can say to defend the question writer here!! ?
Hope thats some help ( your query is totally valid!)
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