Question

Hayden Inc. has a number of copiers that were bought four years ago for $37,000. Currently maintenance costs $3,700 a year, but the maintenance agreement expires at the end of two years, and thereafter, the annual maintenance charge will rise to $9,700. The machines have a current resale value of $9,700, but at the end of year 2, their value will have fallen to $5,200. By the end of year 6, the machines will be valueless and would be scrapped.

Hayden is considering replacing the copiers with new machines that would do essentially the same job. These machines cost $32,000, and the company can take out an eight-year maintenance contract for $1,800 a year. The machines would have no value by the end of the eight years and would be scrapped.

Both machines are depreciated using seven-year straight-line depreciation, and the tax rate is 35%. Assume for simplicity that the inflation rate is zero. The real cost of capital is 8%.

a. Calculate the equivalent annual cost, if the copiers are:

(i) replaced now _______

(ii) replaced two years from now_______

(iii) replaced six years from now_______

b. When should Hayden replace its copiers?

• Replace now

• Replace after two years

• Replace after six years

Answer 1