A firm is considering replacing a machine that has been used drug refining proce

Question

A firm is considering replacing a machine that has been used drug refining process. The financial data for the new improved machine is as follows: Investment cost $27,000 (installed) Estimated useful life of 5 years Salvage value of $16,500 after the first year, decreasing at a rate of 12% each year Operating and maintenance costs are expected to be $2,375 in the first year increasing at a rate of 45% each year. The financial data for the existing machine is as follows: Investment cost $25,000 (installed), 2 years ago Estimated useful life of 7 years from time of purchase .Salvage value of $5,200 after the first year (from today), decreasing at a rate of 12% each year. Current market value of $13,700 Operating and maintenance costs for the next 5 years are expected to be $2,750 in the first year increasing at a rate of 60% each year. With a MARR of 15%, calculate the following: a. Calculate the economic service life for each option. [4+4 points] b. What are your conclusions? [2 points] c. When should the defender be replaced? What are your final conclusions? [41 points]

Explanation / Answer

Cost of new machine now 27000 Add: PV of Operating and maintenance costs 2375 0.8695 2065 3444 0.7561 2604 4993 0.6575 3283 7240 0.5717 4139 10499 0.4971 5219 17310 44310 Less: PV of salvage value at the end of 5 yr. 9895 0.4971 4919 4919 39391 Equivalent annual cost (EAC) ($39,391 / 3.3519 11752 PV of cost of replacing the old machine in each of 5 years with new machine Scenario Year CashFlow PV@15% PV Replace Immediately 0 -11752 1.00 -11752 13700 1.00 13700 1948 Replace in one year 1 -11752 0.87 -10218 1 -2750 0.87 -2391 1 5200 0.87 4521 -8088 Replace in two years 1 -2750 0.87 -2391 2 -11752 0.76 -8886 2 -3988 0.76 -3015 2 4576 0.76 3460 -10832 Replace in three years 1 -2750 0.87 -2391 2 -3988 0.76 -3015 3 -11752 0.66 -7727 3 -5782 0.66 -3802 3 4027 0.66 2648 -14287 Replace in four years 1 -2750 0.87 -2391 2 -3988 0.76 -3015 3 -5782 0.66 -3802 4 -11752 0.57 -6719 4 -8384 0.57 -4793 4 3544 0.57 2026 -18694 Replace in five years 1 -2750 0.87 -2391 2 -3988 0.76 -3015 3 -5782 0.66 -3802 4 -8384 0.57 -4793 5 -11752 0.50 -5842 5 -12156 0.50 -6043 5 3118 0.50 1550 -24336 Conclusion: The company should replace the old machine immediately because the PV of cost of replacing the old machine with new machine is least. working notes: new machine old machine salvage Ope& maintenance salvage Ope& maintenance 88% 45% 88% 60% 16500 2375 5200 2750 14520 3444 4576 3988 12778 4993 4027 5782 11244 7240 3544 8384 9895 10499 3118 12156

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