Question

5 years ago, a multi-axis NC machine was purchased for the express purpose of machining large, complex parts used in commercial and military aircraft worldwide. It cost $350,000, had an estimated life of 15 years, and O&M costs of $50,000 per year. It was originally thought to have a salvage value of $20,000 at the end of 15 years but is now believed to have a remaining life of 5 years with no salvage value at that time. With business booming, the existing machine is no longer sufficient to meet production needs. It can be kept and supplemented by purchasing a new, smaller Machine S for $190,000 that will cost $38,000 per year for O&M, have a life of 10 years, and salvage value of $190,000(0.8^t) after t years. As an alternative, a larger, faster, and more capable Machine L can be used alone to replace the current machine. It has cash price without trade-in of $420,000, O&M costs of $74,000 per year, salvage value of $420,000(0.8^t) after t years, and a 15 year life. The present machine can be sold on open market for a maximum of $70,000, MARR is 15%, and the planning horizon is 5 years.

a. Clearly show the cash flow profile for each alternative using a cash flow approach (insider’s viewpoint approach). Provide cash flow for year t=0, 3 and 5.

b. Using an EUAC and a cash flow approach (insider’s viewpoint approach), decide which is the more favorable alternative.

c. Using an EUAC comparison and an opportunity cost approach (outsider’s viewpoint approach), decide which is the more favorable alternative.

d. Using an EUAC comparison and an opportunity cost approach (outsider’s viewpoint approach), decide which is the more favorable alternative.

Answer 1

Alternate 1 : Continue with Machine NC with new supplementing Machine S.

Alternate 2 : Purchase Machine L.

a)  

Year	Alternate 1	Alternate 2
0	-190000	-420000
3	-88000	-74000
5	-25741	63626

b) Calculation of EUAC of both alternative (cash flow approach):

NPV of Alternate 1 = -190000-76522-66541-57861-50314-12798 = -$454,036

EUAC of Alternate 1 = P*(1-(1+r)^-n)/r = -454036/[(1-(1+0.15)^-5))/0.15] = -$135,446

NPV of Alternate 2 = -350000-64348-55955-48656-42310+31633 = -$529,636

EUAC of Alternate 2 = P*(1-(1+r)^-n)/r = -529636/[(1-(1+0.15)^-5))/0.15] = -$157,999

Decision: EUAC of Alternate 1 is more than Alternate 2, hence Alternate 1 should be favorable.

c) & d) Please note you have asked same question in part c & d

Calculation of EUAC of both alternative (opportunity cost approach):

NPV of Alternate 1 = -260000-76522-66541-57861-50314-12798 = -$524,036

EUAC of Alternate 1 = P*(1-(1+r)^-n)/r = -524036/[(1-(1+0.15)^-5))/0.15] = -$156,328

NPV & EUAC of Alternate 2 same as calculated above i.e. -$529,636 & -$157,999 respectively.

Decision: EUAC of Alternate 1 is more than Alternate 2, hence Alternate 1 should be favorable.

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