Question

An old equipment produces a lot of defective parts. It is estimated that during the next four years will produce 1,200 defective parts each year, while after the fifth year, this number would increase by 150 pieces each year, beginning this increase in year number 5. The company uses as reference an interest rate of 9%. Doing a study for the next eight years, how much would the company be willing to pay now for a new machine that totally avoids this problem, if each defective piece costs $ 10? Draw flow diagram.

Answer 1

cost of defective parts = 10

No of defective parts each year for four years = 1200

Value of defective parts = 1200*10 = 12000

value of increase = 150*10 = 1500 each year from year 5 uptill year 8

i = 9%

Present value of defective parts = 12000*(P/A, 9%,8) + 1500*(P/G,9%,5) *(P/F,9%,3)

= 12000*5.534819 + 1500*7.111048 *0.772183

= 74654.38

This is the maximum amount a company would be willing to spend on new machine

Cash flow diagram