Your company needs a machine for the next seven years, and you have two choices

Question

Your company needs a machine for the next seven years, and you have two choices (assume an annual interest rate of 15%). Machine A costs $130,000 and has an annual operating cost of $36,000. Machine A has a useful life of seven years and a salvage value of $11,000 Machine B costs $160,000 and has an annual operating cost of $25,000. Machine B has a useful life of five years and no salvage value. However, the life of Machine B can be extended by two years with a certain amount of investment. If Machine B's life is extended, it will still cost $25,000 annually to operate and still have no salvage value. What would you pay at the end of year 5 to extend the life of Machine B by two years?

Explanation / Answer

R = 15%

Useful life of machine A = 7 years

Useful life of machine B = 5 year (can be extended for 2 more years)

Let, Amount paid at the end of year 5 for machine B = X

If life is extended for 2 more years of machine B, then present worth of machine A should be equal to the present worth of the machine B.

130000 + 36000*(1-1/1.15^7)/.15 - 11000/1.15^7 = 160000 + 25000*(1-1/1.15^7)/.15 + X/1.15^5

275639.8 = 264010.5 + X*.4972

X = (275639.8-264010.5)/.4972

X = $23389.58

So, the amount of $23389.58 should be paid at the end of year 5 in machine B.

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