4. Your company needs to purchase a new heat exchanger. There are two options: a

Question

4. Your company needs to purchase a new heat exchanger. There are two options: an inexpensive heat exchanger with a short lifetime and no scrap value, and a more expensive heat exchanger with a longer lifetime that can be sold for scrap. (Hint: the replacement cost is the purchase cost minus the scrap value.) Your company expects to earn a 15% effective annual compound interest rate on all of its investments. Complete the table below. Which heat exchanger should your company purchase? Heat Exchanger Price Cy(years) Purchase Lifetime Scrap Value Replacement Capitalized cost C Cost $20,000 $35,000 10 $4,000

Explanation / Answer

For A:

Replacement value = purchase cost - scrap = 20,000 - 0 = 20,000

Capitalized cost = 20,000/6 = 3,333.33 per year (annually)

Net present value = 20,000

equivalent annual cost of A = NPV * r/(1-(1+r)^-n) = 20,000*0.15/(1-1.15^-6) = 5,284.73

For B:

Replacement cost for B = 35,000-4,000 = 31,000

Capitalized cost for B = 31,000/10 = 3,100 per year (annually)

Net present value for B = 35,000 - 4,000/1.15^10 = 34,011.26

Equivalent annual cost for B = NPV * r/(1-(1+r)^-n) = 34,011.26*0.15/(1-1.15^-6) = 6,776.81

Since the euvivalent annual cost for A is lower than that of B, we would prefer Heat exchnager A

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