Question

Three years from now (now =Year 0) the equipment that Dark Star Technologies uses to coat and protect the surfaces on its products will have to be replaced. Dark Star plans to operate the new equipment for 7 years (Years 4 to 10). The company is considering two procurement options.

Option 1: MAKE the manufacturing equipment in-house. The yearly acquisition costs associated with developing the equipment in-house are as follows: Year 1 = $200,000, Year 2 = $700,000, Year 3 = $1,000,000. The Annual Operation & Maintenance Cost of the in-house developed equipment will be $100,000 (Years 4 to 10). Assume the equipment has zero salvage value.

Option 2: BUY manufacturing equipment available from ACME Specialties. The acquisition cost associated with purchasing the equipment is $1,000,000 (Year 3). The Annual Operation and Maintenance Cost of the manufacturing equipment purchased from Acme Specialties will be $300,000 (Years 4 to 10). Assume the equipment has zero salvage value. For an interest rate = 10%

a) Calculate the equivalent cost at future Year 3 of Option 1 and Option 2. Year 3 is when the system goes into operation, i.e., the end of the production phase for Option 1 (MAKE) or when the purchased equipment is ready for use OPTION 2 (BUY).

b) Which option should Dark Star Technologies choose based on equivalent costs?

Please show what equations are used

Answer 1