A lumber company that cuts fine woods for cabinetry is evaluating if it should r
ID: 2786423 • Letter: A
Question
A lumber company that cuts fine woods for cabinetry is evaluating if it should retain the current bleaching system
or replace it with the new one. The relevant costs of each system are known or estimated.
Current System
First Cost seven years ago, $-450,000
Remaining Life, years 5
Current market value, $ 50,000
Annual Operating Costs, $/year -$160,000
Future Salvage, $0.00
New System
First Cost, $ 700,000
Remaining Life, years 10
Annual Operating Costs, $/year -150,000
Future Salvage, $ 50,000
Use an interest rate of 10% per year to
a) Perform the replacement analysis and
b) Determine the minimum resale price needed to make the challenger replacement choice now.
Explanation / Answer
a) AWcurr = -50,000(A/P,10%,5) -160,000
= -50,000(0.2638) - 160,000
= -173190
AWnew = -700,000(A/P,10%,10) -150,000 + 500,000(A/F,10%,10)
= -700,000(0.16275) -150,000 +500,000(0.06275)
= -260,788
It is better to continue current system for 5 years as the AW is more positive compared to new system.
b)
-260788 = M(A/P,10%,5) - 160,000
-260788 = 0.2368M -160,000
M = -382,060
Not reasonable since the current system has been used for more than half of its service life ( 7 of 12 years) and after 60% of its service life ,the price should not be 85% of the original cost.
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