General Food Company is considering replacing an old food dispenser which was pu
ID: 2793327 • Letter: G
Question
General Food Company is considering replacing an old food dispenser which was purchased 10 years ago at a cost of $26,000. It has a current market value of $6000. If the firm spends $2000 to recalibrate the dispenser, it would extend the life of the dispenser for another three years with the following estimated market values and operating costs: Year 0: Market value $6000; Overhaul $2000 Year 1: Market value $4300; O&M cost $3800 Year 2: Market value $2500; O&M cost $5100 Year 3: Market value $1000; O&M cost $6500 The firm`s MARR is 10%. Ignore any income tax effects for this problem. What is the remaining economic service life of the machine with the overhaul? Hint: consider the overhaul as one-time O&M cost in year 0. Enter your answer as an integer between 1 and 3.
Explanation / Answer
Year 0
Current market value
6000
Overhaul cost at Y0
2000
Total cost
8000
Particulars
Year1
Year 2
Year 3
O & M Costs
3800
5100
6500
Market value
4300
2500
1000
PVAF @ 10%
0.909091
0.826446
0.751315
Cumulative PVAF
0.909091
1.735537
2.486852
NPV if machine is kept at year 1
=(8000*-1)-3800*0.909+4300*0.909
=-7545.5
NPV if machine is kept at year 2
=(8000*-1)-3800*0.909-5100*0.826446+2500*0.826446
=-13602.9596
NPV if machine is kept at year 3
=(8000*-1)-3800*0.909-5100*0.826446-6500*0.751+1000*0.751
=-19799.5746
Since above NPV figures are relate to different periods, there are not comparable. To make them comparable we shall use concept of EAC as under:
EAC(Equivalent Annual Cost)=NPV/Cumulative PVAF
EAC of 1 year
=7545.5/0.909
=8300.880088
EAC of 2 year
=13602.96/1.736
=7835.806452
EAC of 3 year
=19799.574/2.489
=7954.830856
Since, EAC is lowest for 2 years, hence the machine's economic life is 2 years.
Year 0
Current market value
6000
Overhaul cost at Y0
2000
Total cost
8000
Particulars
Year1
Year 2
Year 3
O & M Costs
3800
5100
6500
Market value
4300
2500
1000
PVAF @ 10%
0.909091
0.826446
0.751315
Cumulative PVAF
0.909091
1.735537
2.486852
NPV if machine is kept at year 1
=(8000*-1)-3800*0.909+4300*0.909
=-7545.5
NPV if machine is kept at year 2
=(8000*-1)-3800*0.909-5100*0.826446+2500*0.826446
=-13602.9596
NPV if machine is kept at year 3
=(8000*-1)-3800*0.909-5100*0.826446-6500*0.751+1000*0.751
=-19799.5746
Since above NPV figures are relate to different periods, there are not comparable. To make them comparable we shall use concept of EAC as under:
EAC(Equivalent Annual Cost)=NPV/Cumulative PVAF
EAC of 1 year
=7545.5/0.909
=8300.880088
EAC of 2 year
=13602.96/1.736
=7835.806452
EAC of 3 year
=19799.574/2.489
=7954.830856
Since, EAC is lowest for 2 years, hence the machine's economic life is 2 years.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.