Question

One of the four ovens at a bakery is being considered for replacement.  A new oven costs $80,000, but this price includes a complete guarantee covering all maintenance costs for the first 2 years and most maintenance costs for year 3.  

The salvage value and maintenance costs for the existing and proposed new ovens, respectively are given in the table below.  Both ovens are similar in productivity and energy costs.  Because of heavy usage, the existing oven has 2 years of life remaining and the new oven has an expected useful life of 3 years.

The bakery asks you to perform an economic analysis using a MARR of 8% per year.  What should the company do?

	Existing Oven		New Oven
Time	Salvage Value	Maintenance Costs	Salvage Value	Maintenance Costs
0	$20,000
1	$17,000	$9,500	$75,000	$0
2	$14,000	$9,600	$70,000	$0
3			$66,000	$5,000

Answer 1

IN CASE OF NO REPLACEMENT
Year	Cash Flow	MARR @ 8%	Present Value
0	0	1	0
1	-9500	0.926	-8796
2	4400	0.857	3772
TOTAL COST AT PRESENT VALUE	5024

Replacement to new oven( For 2 years)
Year	Cash Flow	MARR @ 8%	Present Value
0	-60000	1	-60000
1	0	0.926	0
2	70000	0.857	60014
TOTAL COST AT PRESENT VALUE	-14

Only 2 years have been considered for the new oven to make the decision on even basis since the old oven has useful life of only 2 years.Cash Outflow in Year 0 = 80000-20000(scrap of old oven) = 60000

Replacement is recommended as its present cost will be lower than the case if no replacement is done and we can also say that the cash flow is nil.