Question

Michelin is considering going ‘‘lights-out’’ in the mixing area of the business that operates 24/7. Currently, personnel with a loaded cost of $560,000 per year are used to manually weigh real rubber, synthetic rubber, carbon black, oils, and other components prior to manual insertion in a Banbary mixer that provides a homogeneous blend of rubber for making tires (rubber products). New technology is available that has the reliability and consistency desired to equal or exceed the quality of blend now achieved manually. It requires an investment of $2,300,000, with $95,000 per year operational costs and will replace all the manual effort described above. The planning horizon is 8 years, and there will be a $260,000 salvage value at that time for the new technology. Marginal taxes are 25%, and the after-tax MARR is 10%.

Determine the annual cost of purchasing the new technology.

Answer 1

Ans:

Calculation of annual cost of new technology:

Equipment value : $2,300,000

Salvage value after 8 Years : $260,000

Depriciation Annually : ($2,300,000- $260,000) / 8 = $255,000

Depriciation tax saving : $255,000*25% = $63,750 Per year.

Operational costs per year : $95,000

Present value factor @10% for 8 Years : 1/(1.10)^8 = 0.466507

Present value of salvage value : $260,000 * 0.466507 = $121,292

Present value of equipment cost - Present value of salvage value : $2,300,000 - $121,292 = $2,178,708

Annuity factor for 8 year @10% = 1/(1.10)^1 + 1/(1.10)^2 + 1/(1.10)^3 +.........1/(1.10)^8 = 5.33492

Effective annual cost of equipment : $2,178,708 / 5.33492 = $408,386

Annual Cost of new technology : $408,386 + $95,000 - $63,750 = $439,636

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