Question

2. State Electric wants to decide whether to repair or replace electric meters when they break down. A new meter cost $30 and, on the average, will operate for 12 years without repair. It costs $18 to repair a meter, and a repaired meter will, on average, operate for 8 years before it again needs a repair. Repairs can be made repeatedly to meters because they are essentially rebuilt each time they are repaired. It costs $6 to take out and reinstall a meter. The time value of money is 0.05. Should the company repair old meters or buy new meters?

	New (A)	Old (B)
Cost	($30)	($18)
Take out and reinstall cost	($ 6)	($ 6)
Horizon	12 years	8 years

Answer 1

Decision making:repair or replace meter

For the above two options time horizon is different. So we must work our equivalent annual cost of two options

1.EAC for option1:buy new one

EAC = Initial Investment*Discount rate/(1+discount rate^)-n

n =number of years =12

Discount rate =0.05=5%

EAC=($30+$6)*5%/1-(1+.05)^-12

      =$36*5%/1-(1.05)^-12

=$36*5%/1-0.556837

=$1.8/0.443163

=$4.061715

2. 1.EAC for option2:Repair

EAC = Initial Investment*Discount rate/(1+discount rate^)-n

n =number of years =8

EAC=($18+$6)*5%/1-(1+.05)^-8

      =$24*5%/1-(1.05)^-8

=$1.2*/1-0.676839

=$1.2/0.323161

=$3.713324

Thus Equivalent annual cost of repair,=$3.713324<$4.061715(EAC of replace)

So,the Company should repair old meter,