Question

A machine whose operating and maintenance expenses are increased to a rate of $ 20,000 / year can be repaired. With the repair whose cost is $ 150,000, increments in operating and maintenance expenses would be eliminated. For a THREAM of 20% and a planning horizon of 5 years, would it be advisable to repair the machine?

Answer 1

The operating and maintenance expenses are increased at the rate of $20,000 per year.

So,

Expense in first year would be $20,000 and it will increase by $20,000 thereafter each year for 5 years.

Calculate the present value of operating and maintenance expenses -

Present value = $20,000(P/A, 20%, 5) + $20,000(P/G, 20%, 5)

Present value = [$20,000 * 2.9906] + [$20,000 * 4.9061]

Present value = $59,812 + $98,122

Present value = $157,934

The present value of operating and maintenance expenses is $157,934.

This operating and maintenance cost can be eliminated by undertaking a repair that will cost $150,000.

It can be seen that repair cost is less than the present value of operating and maintenance expense.

Thus, it would be advisable to repair the machine.