A $40,000 machine will be purchased by a company whose interest rate is 12%. The

Question

A $40,000 machine will be purchased by a company whose interest rate is 12%. The installation cost is $5K, and the removal costs are insignificant. What is its economic life if its salvage values and O&M costs are as follows:

Year        1           2              3            4           5

S            $35K      $30K        $25K       $20K      $15K

O&M       $8K       $14K        $20K        $26K     $32K

Explanation / Answer

intial value at year 0 =40k - 5k =35k interest every year = 0.12*40000 = 4800 value of machine at the end of year 1 = 35-8-4.8 = 23 + salvage value(35) > 0 at the end of year 2 = (35 -8-4.8)-14 - 4.8 = 3.4 + salvage value(30 > 0 at the end of year 3 = 3.4-20-4.8 = -21.4 +salvage value(25) > 0 at the end of year 4 =-21.4 -4.8-26 = -52.3 + salvage value(20) < 0 hence it is not feasible to operate the machine from year 4 hence the machines operating life is 3 years

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