Question

Mr. Garcia sold his machine for P20,000 after using it for 6 years. He bought a new machine worth 75,000 with an expected life of 12 years and a salvage value of 2,000. The operating cost is P5,500 per year. The old machine which he bought for P50,000 when new will be useful for 10 years and a junk value of 1,000 but because of appropriate maintenance, it will be useful for another 5 years, no salvage value, with an annual operating cost of twice the new one. If money is worth 12%, was the engineer justified in selling the old machine? Use the ROR method.

Thank you! Please provide a detailed solution.

Answer 1

Annual Operationg cost of Old Machine = 2 * 5500 = 11000

There is no other expense or income if old machine is continued to use, So Equated annual cost of old machine is 11000

New Machine:

Cash out flow at year 0 = 75000 - 20000 = 55000

Operating Cost every year = 5500

Salvage value at end of year 12 = 2000

Net present cost of New Machine = (55000 * 1) + ( 5500 * Sum of PVF @ 12 %, 1 to 12 ) - 2000 ( PVF @ 12%, 12)

= 55000 + (5500 * 6.194) - 2000 (0.256)

= 88555.708

Equated Annual cost of New Machine

= Net present cost * ( PV of Annuity Factor @12% , 12)

= 88555.708 * 0.16

= 14296.15

So EAC is lower for old machine, Old machine should be continued for 5 years rather than upgrading.