After 8 years of use, the heavy truck engine overhaul equipment at Pete’s Truck

Question

After 8 years of use, the heavy truck engine overhaul equipment at Pete’s Truck Repair was evaluated for replacement. Pete’s accountant used an after-tax MARR of 8% per year, tk = 30%, and a current market value of $25,000 to determine AW = $2100. The new equipment costs $75,000, uses SL depreciation over a 10-year recovery period, and has a $15,000 salvage estimate. Estimated BTCF is $15,000 per year. Pete asked his engineer son Ramon to determine if the new equipment should replace what is owned currently. From the accountant, Ramon learned the current equipment cost $20,000 when purchased and reached a zero book value several years ago. Help Ramon answer his father’s question.

Explanation / Answer

For old equipment (heavy truck engine overhaul equipment)

AW = $2100

For new equipment

Cost = 75000

Useful life = 10 years

Salvage value =$ 15000

Annual Depreciation = (75000 – 15000) / 10 = $6000

BTCF per year = $15000

BTCF per year (after depreciation) = 15000 – 6000 = 9000

ATCF per year (after depreciation) = 9000*(1-30%) = $6300

AT final cash flow = 6300+depreciation = 6300+6000 = $12300

Net present value = 12300*(1-1/(1+8%)^10) / .08   + 15000/(1+.08)^10 - 75000 = $14481.9

14481.9 = AW*(1-1/(1+.08)^10) / .08 = AW*6.71

AW for new machine = 14481.9 / 6.71 = $2158.25

Ramon can go with the replacement of old equipment as AW of the new machine is greater than that of old machine spread over a period of useful life.

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