An asset is purchased for $350,000. Its 0&M; costs are $50,000 in the first year
ID: 370314 • Letter: A
Question
An asset is purchased for $350,000. Its 0&M; costs are $50,000 in the first year and are expected to grow 25% each year through its maximum service life of five years. The salvage value of the asset drops 30% after the first year and an additional 10% each year thereafter. If the interest rate is 15%, a. What is the economic life of the asset? b. If an asset currently owned is 3-years-old, should it be kept or replaced? If kept, for how long? Do this using the marginal cost analysis. c. Re-solve part (b), assuming that the asset is needed to be service for only four more periods. Do this using the EAC method. Reconsider the above asset again, but assume that a superior challenger is available which costs $360,000. However, 0&M; costs for the challenger start at $40,000 and increase 15%each year, while the salvage value declines 10% each period. The challenger also has a maximum service life of five years. d. . If this asset is the only challenger for the foreseeable future, when should the three- year-old asset from above be replaced, assuming an infinite horizon? Use the EAC method. ii. Re-solve part (i) if the horizon is four years. Use the PW method.Explanation / Answer
Solution:-
CapitalCost have two Components: Initial Investment & the SalvageValue at the time of disposal.
The Initial Investment for the Challenger (New Asset) is itsPurchase price. For the defender, we should treat the opportunitycost as its initial investment.
Use N to represent the length of time in years, the asset will bekept; I is the Initial Investment, and Sn is the salvagevalue at the end of the ownership period of N years.
The Operating Costs of an asset include Operating & Maintenance(O&M) costs, labor costs, Material costs & energyconsumption costs.
Economic Service Life Calculation:
AEC = Annual Equivalent Cost
Step:1
AE of Capital Cost:
CR(i) = I(A/P, i, N) – Sn(A/F, i. N)
Step:2
AE of Operating Cost:
OC(i) = Nn=1 OCn (P/F,i, n) (A/P, i, N)
Step:3
Total AE Cost:
AEC = CR(i) + OC(i)
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