Your company currently owns a machine that is costing you $60,000 per year. You

Question

Your company currently owns a machine that is costing you $60,000 per year. You are considering replacing it with a new machine that would have a first cost of $60,000, and annual operating costs of $30,000 per year for three years. You have received three different estimates of the eventual salvage value of the new machine: $10,000; $15,000; and $20,000. If your company’s minimum acceptable rate of return is 12% per year, is the decision of whether to replace the machine sensitive to the estimated salvage value?

Explanation / Answer

Find the annual equivalent cost of new machine under three different salvage values

AEC(S = 10000) = 60000(A/P, 12%, 3) + 30000 - 10000(A/F, 12%, 3) = 60000*0.41635 + 30000 - 10000*0.29635 = 52017.50

AEC(S = 15000) =  60000(A/P, 12%, 3) + 30000 - 15000(A/F, 12%, 3) = 60000*0.41635 + 30000 - 15000*0.29635 = 50535.75

AEC(S = 20000) =  60000(A/P, 12%, 3) + 30000 - 20000(A/F, 12%, 3) = 60000*0.41635 + 30000 - 20000*0.29635 = 49054

Since the annual equivalent cost of new machine is anyways less than 60,000, annually, the value of salvage value does not matter because AECs are lower than 60000 for any salvage value

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