Question

A 3-year-old machine purchased by the company for $200,000 is getting old and unable to meet today’s market demands. The machine can be upgraded now for $80,000 or sold for $40,000. The current machine will have an annual operating and maintenance (O&M) cost of $100,000 and a $30,000 salvage value in 3 years. If upgraded, the old machine will be retained for only 3 more years, then replaced with a new machine.

The replacement machine, which can serve the company now and for at least 8 years, costs $200,000. In addition, there are shipping and handling charges of $20,000. Its salvage value will be $40,000 for years 1 through 4; $20,000 after 5 years; and $10,000 thereafter. It will have an annual operating and maintenance cost of $65,000 per year.

The company wants to perform an economic analysis at 15% per year using a 3-year planning horizon.

Compare the Capital Recovery (CR) for the replacement machine (challenger) over the study period of 3 years and an expected life of 8 years. Use 4 decimal places of the compound interest factors to do your calculation. Show detailed steps of your replacement analysis.

Answer 1

PARTICULARS	EXISTING
		$
IF WE UPGRADE THE EXISTING MACHINE		80000
OPERATING & MAINT . COST	100000
FOR THREE YEARS
PRESENT VALUE FACTOR 15% FOR THREE YEARS	2.283
PRESNET VALUE OF OPERATING COST IS	100000*2.283	228300
		308300
SCRAP VALUE AT THE END OF THREE YEAR	30000
LESS PRESNT VALUE FACTOR IN YEAR THREE   OF SCRAP	0.657	19710
PRESNT VALUE OF NET CASH FLOW		288590
EQUIVALENT CASH OUFLOW PER ANNUM	288590/2.283	126408.2348
PURCHASE COST OF NEW MACHINE	200000+20000	220000
PLUS SHIPPING CHARGE
LESS SALE VALUE OF OLD MACHINE		40000
NET CASH FLOW IN YEAR 1		180000
OPERATING & MAINT . COST	65000
FOR THREE YEARS
PRESENT VALUE FACTOR 15% FOR THREE YEARS	2.283
PRESNET VALUE OF OPERATING COST IS	65000*2.283	148395
SCRAP VALUE AT THE END OF THREE YEAR	40000
LESS PRESNT VALUE FACTOR IN YEAR THREE   OF SCRAP	0.657	26280
PRESNT VALUE OF NET CASH FLOW		302115
EQUIVALENT CASH OUFLOW PER ANNUM	302115/2.283	132332.4573
IN THIS EQUIVALENT CASH OUFLOW PER ANNUM IS LOWER IN CASE 1 AS UP
GRADING THE MACHINE. SO WE GO FOR UPGRADTION   FOR THREE YEARS AND AFTER
THAT GO PURCHASE OF NEW MACHINE
CAPITAL RECOVERY MEANS
RETURN OF INVESTED CAPITAL OVER AN INVESTMENT LIFE SPAN