Question

Ahmad has inherited a family business of producing sodas. In his newly managing company, he has a machine (Super-Soda-Maker 2000) that can produce 500 cans of soda per hour. This machine requires maintenance every year with a cost of $125,000 and increasing by $50,000 each year starting at year 3. Ahmad is deciding whether to retire 10 years from now, or 5 years from now. If he retires 10 years from now he can sell the machine for $20,000 but if he chooses to retire 5 years from now he can sell the machine for $55,000. Each can of soda is sold at $0.89. The company operates for 8 hours per day, and after considering holidays and vacations, the company works only for 200 days per year. All other operating expenses like salaries, rent, electricity, taxes, etc. are fixed costs estimated to be $100,000 per year regardless of when he will retire. MARR = 10%.

a) Should Ahmad retire in 5 years or in 10 years? Show your work. Explain why

Answer 1

Here,

Soda can produced per hour = 500

Number of working hours a day = 8

Number of working days in a year = 200

So soda can produced per year = 200*8*500 = 800000

Price of Can of Soda= $0.89

Yearly Revenue = 0.89*800000 = $712000

Maintainance cost in year 1 and 2 = $125,000

Maintainance cost increases by $50000 every year after that

Fixed Cost = $100,000

Salvage Value after 5 years = $55,000

Salvage Value after 10 years = $20,000

So Cash Flow if machine operated for 5 years,

	28-07-2021	28-07-2022	28-07-2023	28-07-2024	28-07-2025
	Year 1	Year 2	Year 3	Year 4	Year 5
Revenue	712000	712000	712000	712000	712000
Operating Cost	125000	125000	175000	225000	275000
Fixed Cost	100000	100000	100000	100000	100000
Salvage Value					55000
Cash Flow	487000	487000	437000	387000	392000

Net Present Value for 5 years,

= 487000/ (1+.1) + 487000/((1+.1)^(2))+ 437000/((1+.1)^(3))+ 387000/((1+.1)^(4))+ 392000/((1+.1)^(5))

NPV = $1681258.5

So Cash Flow if machine operated for 10 years,

	28-07-2021	28-07-2022	28-07-2023	28-07-2024	28-07-2025	28-07-2026	28-07-2027	28-07-2028	28-07-2029	28-07-2030
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Revenue	712000	712000	712000	712000	712000	712000	712000	712000	712000	712000
Operating Cost	125000	125000	175000	225000	275000	325000	375000	425000	475000	525000
Fixed Cost	100000	100000	100000	100000	100000	100000	100000	100000	100000	100000
Salvage Value										20000
Cash Flow	487000	487000	437000	387000	337000	287000	237000	187000	137000	107000

Net Present Value for 10 years,

= 487000/ (1+.1) + 487000/((1+.1)^(2))+ 437000/((1+.1)^(3))+ 387000/((1+.1)^(4))+ 337000/((1+.1)^(5))+ 287000/((1+.1)^(6))+ 237000/((1+.1)^(7))+ 187000/((1+.1)^(8))+ 137000/((1+.1)^(9))+ 107000/((1+.1)^(10))

NPV = $2117321.75

Since Net present value for working for 10 years is higher, hence he should retire after 10 years