Question

1. A machine costs $35,000 and has an estimated scrap value of $3,000 at the end of eight years. It produces 5,000 units of output per year and the annual maintenance cost is $1,500.

a) What is the depreciation expense in year three assuming the constant percentage method?

b) How much would you recommend be spent on increasing the machine’s outputby 30% and extending its useful lifetime to 12 years? Assume j1 = 4% and the scrap value and maintenance costs stay the same.

Answer 1

a) For calculation of depreciation, firstly depreciation rate = (Final value/Initial value)^(1/8) -1

= (3000/35000)^(1/8) -1 = - 0.264417 or 26.44% p.a

Depreciation expense during third year= book value at end of year 2 * depreciation rate

= 35000* (1-0.264417)²*0.264417

= $5000

b) The increase in output of 30% consideration cannot be quantified, as the profit is not known in the query

But it can be stated, the increase in life would shorten the NPV of equivalent annual cost (EAC)

Earlier EAC = 35000*0.04/(1-1/1.04⁸) +1500 - 3000*0.04/(1.04⁸-1) = $6372.89

If $X is spent ,EAC should remain the same

New EAC = (35000+X)*0.04/(1-1/1.04¹²) + 1500 - 3000*0.04/(1.04¹²-1) = 6372.89

X= $12606.72

An amount of $12606.72 can be spent