You supervise an aging production line that constantly needs maintenance and new

Question

You supervise an aging production line that constantly needs maintenance and new parts. Last month you spent $25,000 replacing a failed controller. Should the following plan be accepted if the interest rate is 15%. The net installed cost of the new line is $600,000 with a useful life of 6 years. First year of operation will cost $100,000 and will generate annual revenues of $300,000. Each year the operating cost will increasse by $5,000 and revenues will fall $15,000. After 6 years the equipment will have a value of $100,000 in the next re-building of the line.

Explanation / Answer

First, $25,000 is a sunk cost.

New plan = -600 + (300-100)(P/A, 15, 6) - 20(P/G, 15, 6) + 100(P/F, 15, 6)

= -600 + (200)(3.784) - 20(7.937) + 100(.4323)

= $41.29k or $41.3k

The new plan may be better--although data from the old production line is not given; there is not a concrete way to know if it is more cost efficient until data from the old line is known.

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