You are considering the purchase of one of two machines used in your manufacturi

Question

You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1000 initially, and then $300 per year in maintenance costs. Machine B costs $1300 initially, has a life of three years, and requires $200 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 8% and the tax rate is zero.

Year

0

1

2

3

Machine A

Year

0

1

2

3

Machine A

Explanation / Answer

Machine B is better

Let us calculate the cost incurred in the case of both the machines for the first three years

For machine A life is 2 years , then we have to buy a new one again costing $1000

Now cost incurred for three years if we buy machine A = 1000 + 300/1.08 + 300/1.08^2 + 1000/1.08^3 =$2328.81

Life of machine B is 3 years

So the cost incrred for 3 years if we take machine B is

1300+200/1.08+200/1.08^2+200/1.08^3 =$1815.42

Clearly machine B costs less so it is better

Though if you calculate for year 4 Machine B will show more cost but eventually cost of Machine A will overtake for all years because it needs to be replaced every two years

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