Question

1. A 2-year old injection molding machine was expected to serve out its projected life of 5 years, but a challenger promises to be more efficient and have lower operating costs. We want to perform an AW evaluation to determine if it is economically attractive to replace the defender now or keep it for 3 more years as originally planned.

            The defender had a first cost of $300,000, but its market value now is only $100,000. It has chargeable expenses of $120,000 per year and no expected salvage value. Assume that SL depreciation was charged (at $60,000 per year) for five years.

            The challenger will cost $420,000; have no salvage value after its 3-year life; have chargeable expenses of $30,000 per year, and be SL-depreciated (at $140,000 per year).

Assume the company’s effective tax rate is 35% and its after-tax MARR is 15% per year. Since GI is not estimated, all taxes will be negative. Conduct the replacement study to determine if the defender should be kept for 3 more years or replaced now

Answer 1

Annual worth = - Initial cost ( A/P , i, n) - Annual cost - Annual benefits.

Depreciation is charged on defender = $60000 per year  

Tax benefit on defender depreciation = ($60000 * 35%) = $21000

Depreciation is charged on challenger = $140000 per year

Tax benefit on challenger depreciation = ($140000 * 35%) = $49000

Annual worth of defender = -$100000 ( A/P , i n ) - $120000 + $21000

= -$100000 ( A/P , 15%, 3) - $99000

= -$ 100000 ( 0.438) - $99000

= $142797.70

Annual worth of challenger = - $420000 ( A/P , i , n) - $30000 +$49000

= -$420000 ( 0.438) + $19000

= $164960

Decision : Since defender has less cost we should keep defender for 3 more years.