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3-3 Machine \"A\" has an initial cost of $50,000, an estimated service period of

ID: 1132421 • Letter: 3

Question

3-3 Machine "A" has an initial cost of $50,000, an estimated service period of 10 years, and an estimated salvage value of S10,000 at the end of the 10 years. Estimated end-of-year annual disbursements for operation and maintenance are $5,000. A major overhaul costing $10,000 will be required at the end of 5 years. An alternate Machine "B" has an initial cost of $40,000 and an estimated zero salvage value at the end of the 10-year service period with estimated end-of-year disbursements for operation and maintenance of $8,000 for the first year, $8,500 for the second year, and increasing $500 each year thereafter. Using a minimum ROR of 10%, compare the present worth costs of 10-year service from Machines "A" and "B."

Explanation / Answer

Machine A

Machine B

First Cost = 50,000

Annual Operating Cost = 5,000

Salvage Value = 10,000

Major overhaul cost at 5th year = 10,000

Life = 10 years

ROR = 10%

NPW = 50,000 + 5000 (P/A, 10%, 10) +

           10,000 (P/F, 10%, 5) –

           10,000 (P/F, 10%, 10)

NPW = 50,000 + 5000 (6.145) +

           10,000 (.6209) –

           10,000 (.3855)

NPW = 83,079

First Cost = 40,000

Annual Operating Cost = 8,000 in the 1st year that increases by 500 each year

Life = 10 years

ROR = 10%

First compensating the gradients and calculating uniform cash flow

A1 = 8,000

G = 500

A = A1 + G (A/G, 10%, 10)

A = 8,000 + 500 (3.725) = 9,862.5

NPW = 40,000 + 9,862.5 (P/A, 10%, 10)

NPW = 40,000 + 9,862.5 (6.145)

NPW = 1,00,605

As both the machines are cost dominated, select the lowest cost machine, i.e. Machine A should be selected because of lowest cost.

Machine A

Machine B

First Cost = 50,000

Annual Operating Cost = 5,000

Salvage Value = 10,000

Major overhaul cost at 5th year = 10,000

Life = 10 years

ROR = 10%

NPW = 50,000 + 5000 (P/A, 10%, 10) +

           10,000 (P/F, 10%, 5) –

           10,000 (P/F, 10%, 10)

NPW = 50,000 + 5000 (6.145) +

           10,000 (.6209) –

           10,000 (.3855)

NPW = 83,079

First Cost = 40,000

Annual Operating Cost = 8,000 in the 1st year that increases by 500 each year

Life = 10 years

ROR = 10%

First compensating the gradients and calculating uniform cash flow

A1 = 8,000

G = 500

A = A1 + G (A/G, 10%, 10)

A = 8,000 + 500 (3.725) = 9,862.5

NPW = 40,000 + 9,862.5 (P/A, 10%, 10)

NPW = 40,000 + 9,862.5 (6.145)

NPW = 1,00,605

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