Question

In: Economics

Five years ago, Thomas Martin installed production machinery that had a first cost of $25,000. At...

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?

Solutions

Expert Solution

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.


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