Question

Advanced Electrical Insulator Company is considering replacing a broken inspection machine, which has been used to test the mechanical strength of electrical insulators, with a newer and more efficient one. If repaired, the old machine can be used for another five years, although the firm does not expect to realize any salvage value from scrapping it in five years. Alternatively, the firm can sell the machine to another firm in the industry now for $7,500. If the machine is kept, it will require an immediate $1,400 overhaul to restore it to operable condition. The overhaul will neither extend the service life originally estimated nor increase the value of the inspection machine. The operating costs are estimated at $2,500 during the first year and are expected to increase by $1,000 per year thereafter. Future market values are expected to decline by $1,500 per year.

The new machine costs $15,000 and will have operating costs of $1,500 in the first year, increasing by $1,000 per year thereafter. The expected salvage value is $10,000 after one year and will decline 12% each year. The company requires a rate of return of 10%. Find the economic life for each option, and determine when the defender should be replaced.

Answer 1