Question

A piece of equipment now is use at a plant is under consideration for replacement. It has a market value of 8,000. This market value is expected to decline by 50% per period (from the previous period) until it reaches zero at the end of period 3. The estimated operating and repair cost for the next period is 26,000 and this is expected to grow at a rate of 15 percent per period. A replacement has been located that will cost 32,000 to purchase. After one period the market value of this new equipment will be 22,000 and this value is expected to decrease by 35% per period until the expected end of service after 7 periods. The first period operating cost is expected to be 14,000 increasing by 15 percent per year. Applying an interest rate of 12%, answer the questions below.

a. What is the lowest period equivalent cost for keeping the new replacement equipment in operation for its economic service life?  

b. What is the economic service life of the new replacement?  

c. Based on your analysis, what should the decision be now regarding replacement? Code ‘1’ to keep the existing equipment at least one more period; Code ‘2’ to get the replacement now.

Answer 1

Hi

The answer of the following question is given below as follows :

VALUES GIVEN :

OLD EQUIPMENT

Market value = 8000

Decreasein value by 50% (considered as depreciation cost) at the end of the third year, the value will be "0"

Cost of operation and repair = 26000
increase in value by 15% per period

NEW EQUIPMENT

Purchase Price = 32000
next year's value will be = 22000
expected to be reduced by 35% (considered depreciation cost) expected life expectancy 7 years And the operating cost = 14000

So it is expected to increase in the following periods

INTEREST RATE

Interest rate = 12%

The discount rate is considered as 12%.

Weighted AVG Cost of Old Equipmen

​​​​​​

Weighted AVG Cost of New Equipment :

So According to the calculations, the answers will be:

Ans.1)Cost equivalent to least cost period of new replacement equipment = 60,833,755

Ans.2) Economic useful life of the new replacement = 3 years (having the lowest weighted average annual cost)

Ans.3) Now Based on the analysis, the replacement decision will be code "2" ("replace equipment now" because the WEIGHTED AVERAGE COST TO MAINTAIN AN OLD EQUIPMENT IS MORE THAN REPLACE IT).

I hope I have served the purpose well.

Thanks.