Springfield Ironworks (SI) recently had their furnace break down and they need t

Question

Springfield Ironworks (SI) recently had their furnace break down and they need to quickly purchase a new one to minimize the disruption in their production. They can either choose a high quality furnace (H) that costs $130,000 with $4,000 of annual maintenance costs for the 7-year life of the furnace, or a low quality furnace (L) that costs $75,000 with $9,000 in annual maintenance costs for the 4-year life of the furnace. Which furnace should SI choose? What is the annualized cost of their choice? Assume a discount rate of 5.0%, and ignore all taxes.

Explanation / Answer

Calculation of Annualised Cost

Furnance H

Low Quality Furnance

I will prefer high Quality Furnance due to low annualised cost

Cost 130000 Annual maintenance Cost 4000 5.786 23145 Total 153145 Annualised Cost 153145/5.786 = 26469

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