A piece of equipment that was purchased for $25,000 five years ago has a current

Question

A piece of equipment that was purchased for $25,000 five years ago has a current book value of $6,000. This equipment can currently be sold for $ 5,000. This equipment can provide service for another two years with an operating and maintenance cost of $10,000 per year and it can be sold for $500 at the end of two years from now. Since the study period is 5 years, it is proposed that if the old machine is kept now, the work will be outsourced for the last three years at a cost of $15,000 per year paid at the beginning of each of the last three years. A new piece of equipment is available in the market for $40,000. The annual operating and maintenance cost is expected to be only $4,000 per year. The salvage value at the end of the study period of 5 years is expected to be $5,000. If the before-tax MARR is 10% per year compounded yearly, which option should the company select?

Explanation / Answer

Present worth (PW) of costs if old machine is kept & operated ($)

= 1,000** + 10,000 x PVIFA(10%, 2) - 500 x PVIF(10%, 2) + [15,000 x PVIFA(10%, 3) x PVIF(10%, 3)]

= 1,000 + 10,000 x 1.7355 - 500 x 0.8264 + (15,000 x 2.4869 x 0.7513)

= 1,000 + 17,355 - 413 + 28,026

= 45,968

**Loss on sale of old machine = Book value - Sale price = $(6,000 - 5,000) = $1,000

PW of costs if new machine is purchased ($)

= 40,000 + 4,000 x PVIFA(10%, 5) - 5,000 x PVIF(10%, 5)

= 40,000 + 4,000 x 3.7908 - 5,000 x 0.6209

= 40,000 + 15,163 - 3,105

= 52,058

Since present worth of costs is lower if old machine is kept and continued, this option should be chosen.

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