Question

An engineer has been studying a lean process line to determine if the company should switch from one machine (Machine A) to another (Machine B). Assume an interest rate of 10%. Use annual cash flow analysis to determine which machine should be chosen.

	Machine A	Machine B
First Cost	$ 20,000	$ 30,000
Maintenance and Operating Costs	$ 2,000	$ 500
Annual Benefit	$ 10,000	$ 15,000
Salvage Value	$ 5,000	$ 7,500
Useful Life (years)	7	11

Answer 1

Net annual benefit, NAB = Annual benefit - Annual Maintenance cost

NAB, Machine A ($) = 10,000 - 2,000 = 8,000

NAB, Machine B = 15,000 - 500 = 14,500

Annual worth (AW) of both machines is computed as follows.

AW, Machine A ($) = - 20,000 x A/P(10%, 7) + 8,000 + 5,000 x P/F(10%, 7) x A/P(710%, 7)

= - 20,000 x 0.2054** + 8,000 + 5,000 x 0.5132** x 0.2054** = - 4,108 + 8,000 + 527

= 4,419

AW, Machine B ($) = - 30,000 x A/P(10%, 11) + 14,500 + 7,500 x P/F(10%, 11) x A/P(710%, 11)

= - 30,000 x 0.154** + 14,500 + 7,500 x 0.3505** x 0.154** = - 4,620 + 14,500 + 405

= 10,285

Since machine B has higher AW of net benefit, the company should switch from machine A to machine B.

**From A/P and P/F Factor tables