Suppose a company has a forklift but is considering purchasing a new electric li

Question

Suppose a company has a forklift but is considering purchasing a new electric lift truck that would cost $180000 and has operating cost of $30000 in the first year. For the remaining years, operating costs increase each year by 26% over the previous year's operating costs. It loses 25% of its value every year fromthe previous year's salvage value. The lift truck has a maximum life of 6 years. The firm's required rate of return is 4%. Find economic service life of this new machine. Explain your answer.

Explanation / Answer

ECONOMIC LIFE = 3 YEARS.  We see in the above table that cost (EAC) decrease upto 3rd year and there after increases.

(1) EAC (FC) .......... equivalent annual cost of First cost i.e 180000 investment. For calculating this column we have to divide 180000 with sum of discounting factors up to that year. For example for 3rd year 180000 / total discounting factors for 3 years)

(2) EAC(OC) ..........Equivalent annual cost of operating cost. This is calculated by cummulating the operating cost and divide it with the total of the discounting factors. For example in the 3rd year we take the CPV(AOC) which means cumulative present value of annual operating cost and divide it with CDF i.e total of discounting facotors

(3) EAC ( S) ......Equivalent annual salvage value .......... Multiple the salvage value with DF of that year and divide with cummulated DF.

Detailed workings are as under

Column - 2 ........AOC is obtained by multiplying previous value with 1.26.

Column - 3 ........discounting values at 4%

Column - 4 ........CDF ......Cummulative Discounting factors. Adding current year discounting factor to previous CDF

Column - 5........PV(AOC) ........DF * AOC ......... i.e column - 2 * column - 3

Column - 6 .......CPV(AOC) ........cummulative PV(AOC)

Column - 7 .....EAC(AOC) .........Equivalent annual cost of Annual operating cost .......this is calculated by

= CPV(AOC) / CDF

Column - 8 .. EAC (FC) ............180000/ CDF

Year EAC(FC) EAC(OC) EAC(S) Total EAC 1 187200 30000 135000 82200 2 95435.29 33823.53 49632.35 79626.471 3 64862.74 38245.77 24326.47 78782.041 4 49588.21 43371.27 13411.89 79547.58 5 40432.88 49324.15 7886.318 81870.711 6 34337.14 56251.64 4829.828 85758.95

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