Question

Granfield Company has a piece of manufacturing equipment with a book value of $40,000 and a remaining useful life of four years. At the end of the four years the equipment will have a zero salvage value. The market value of the equipment is currently $22,000. Granfield can purchase a new machine for $120,000 and receive $22,000 in return for trading in its old machine. The new machine will reduce variable manufacturing costs by $19,000 per year over the four-year life of the new machine. The total increase or decrease in net income by replacing the current machine with the new machine (ignoring the time value of money) is:A. $22,000 decreaseB. $76,000 increaseC. $18,000 decreaseD. $52,000 increaseE. $22,000 increase

Answer 1

Answer:

A. $22,000 decrease

Explanation:

The reason behind Granfield Company interested in predicting the increase or decrease in net income when they purchase new machinery by selling an old one is because you have the Cash coming through so that they don't run out of money. As per Generally Accepted Accounting Principles (GAAP) the other name of Profits is Net Income. The company may not have Cash in the bank but their Net Income may be in millions. So, when Companies like Granfield when usually invests are usually concerned about their investments that weather they will be profitable or not. In this instance of Granfield Company, they predict that by acquiring the new machinery they will save on manufacturing overhead by $19,000 over 4 years which accumulates to $76,000.

Annual Savings = $19,000 x 4 = $76,000

We are told to ignore the time value of money here so if the proceeds from previous machinery are $22,000, then add the proceeds from machinery and annual savings and we get a total of $98,000

Annual Savings $76,000

Add: Proceeds from Sale of Machine $22,000

Total Savings $98,000

To find the increase or decrease in net income or the effect of purchase of new machinery and disposal of old machinery on net income can be calculated as follows;

Total Savings $98,000

Less: Purchase of New Machinery $120,000

Decrease in Net Income $22,000

Hence the Net Income will decrease by $22,000 which means there will be a decrease in retained earnings and stockholders' equity.

Option A is the Correct answer.