A new machine would cost $18,000, have operating costs of $1,000 in the first ye

Question

A new machine would cost $18,000, have operating costs of $1,000 in the first year, and have a salvage value of $10,000 at the end of the first year. For the remaining years, operating costs increase each year by 15% over the previous year’s operating costs. The salvage value declines each year by 25% for the previous year’s salvage value. The machine has a maximum life of seven years. An overhaul costing $3,000 and $,4500 will be required during the fifth and seventh years of service, respectively. The firm’s required rate of return is 15%. Find the economic service life of this new machine.

Explanation / Answer

Consider the following table:

The minimum total EAC is in year 6 hence its economic service ife is 6 years.

Year Salvage Value Operating cost Overhaul cost Operating and management cost Capital recovery cost EAC Operating cost Total EAC 1 10000 1000 0 1000 10700 1000 11700 2 7500 1150 0 1150 7583.721 1069.767 8653.488 3 5625 1322.5 0 1322.5 6263.715 1142.549 7406.263 4 4218.75 1520.875 0 1520.875 5459.907 1218.314 6678.221 5 3164.063 1749.006 3000 4749.006 4900.4 1741.971 6642.371 6 2373.047 2011.357 0 2011.357 4485.175 1772.745 6257.919 7 1779.785 2313.061 4500 6813.061 4165.665 2228.189 6393.854

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