In: Economics
Five years ago, Thomas Martin installed production machinery that had a first cost of $25,000. At that time initial yearly costs were estimated at $3000, increasing by 10%each year. The market value of this machinery each year would be 70% of the previous year’s value. There is a new machine available now that has a first cost of $27,900 and no yearly costs over its 5-year minimum cost life. If Thomas Martin uses an 8% before-tax MARR, when, if at all, should he replace the existing machinery with the new unit?
Answer :-
Given :-
Thomas martin installed machinery at first cost of = $25,000
Initial early cost = $3000
Increasing by each year =10%
Market value of this machinery each year would be = 70%
New machine has a first cost of = $27,900
Thomas martin uses an 8% before tax MARR
Present value of existing machinery = 25,000 x 70% x 70% x 70% x 70% x 70%
= 25,000 x 0.7 x 0.7 x 0.7 x 0.7 x 0.7
= $4201.75
Present value of expenses saved :-
Yearly cost at year 5 = 3000 x 110% x 110% x 110% x 110% x 110%
= 3000 x 1.1 x 1.1 x 1.1 x 1.1 x 1.1
= $4831.53
Year |
Expense saved ($) (A) |
PVF at 8% (B) |
Present value ($) C = (A) x (B) |
1 | 4,832 | 0.926 | 4,474.43 |
2 | 5,315 | 0.851 | 4,523.07 |
3 | 5,847 | 0.794 | 4,642.52 |
4 | 6,432 | 0.735 | 4,727.52 |
5 | 7,075 | 0.681 | 4,848.08 |
Total | 23,215.62 |
Present value of net cash outflows = cost of new machinary - Resale value of existing machinery
= 27,900 - 4201.75
= 23,698.25
Present value of net cash outflows = $23,698.25
Amount ($) = present value of cash outflow - present value of expenses saved
= 23,698.25 - 23,215.62
= $482.63
So, He should replace the existing machinery with new unit now, as outflow is a small difference or replace it after one year.