2. You are the Maintenance Engineer in a process plant. You are asked to make a

Question

2. You are the Maintenance Engineer in a process plant. You are asked to make a recommendation towards reconditioning old machines or purchasing new ones based on a five (5) year analysis There are two (2) old machines the OM12 and the OM14, which each produce $2.5million worth of products per year. The new machine, the NM600 will produce $7.5m dollars' worth of products per year. Maintenance costs for the OM12 and the OM14 total $2.Smillion per year, combined. There are no set-up costs for the old machines since each machine is permanently set-up to produce the company's two (2) major products. Maintenance for the new machine would total $700,000 per year and set-up costs total $450,000 per ycar. It would cost $5,000,000 to recondition the OM12 and $2,500,000 to recondition the OM14. The cost of buying a new machine such as the NM600 is $24million. If the discount rate is 12%, you are required to: i. Calculate the Net Present Value if the OM12 and OM14 are reconditioned [5 marks i. Calculate the Net Present Value if the NM600 is purchased ili. Select the better option with justification 5 marks 5 marks)

Explanation / Answer

i. Total production from OM12 and OM14 combined = 2*$2.5 million = $5 million per year

Maintenance costs (total) = $2.5 million per year. Cost of reconditioning OM12 and OM14 (assuming the reconditioning is done now) = $5 million+$2.5 million = $7.5 million

PVIF = 1/(1+r)^n = 1/1.12^n where n is the year of cash flow. PV = cash flow*PVIF and NPV = sum of all PVs

NPV for OM12 and OM14 (assuming the reconditioning is being done now):

Thus NPV = $1.51 million or $1,511,940.51

However if reconditioning is done at the end of 5th year then NPV would be:

In this case NPV = $4.76 million or $4,756,239.09

ii. NPV in case of NM699:

Thus NPV = -$1.11 million or -$1,109,671.12

iii. The company should continue with OM12 and OM14 because its NPV>0 and in case of NM600 the NPV<0.

(in $ millions) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash inflow from production 5.00 5.00 5.00 5.00 5.00 less: cash outflows Maintenance costs (2.50) (2.50) (2.50) (2.50) (2.50) Cost of reconditioning (7.50) Net cash flow (a) (7.50) 2.50 2.50 2.50 2.50 2.50 PVIF (b) 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674 PV of cash flows (a*b) (7.50) 2.23 1.99 1.78 1.59 1.42 NPV (sum of all PVs) 1.51

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.