Question

A firm is considering replacing a machine that has been used to make a certain kind of packaging material. The new, improved machine will cost $32,000 installed and will have an estimated economic life of 10 years, with a salvage value of $2,500. Operating costs are expected to be $1,000 per year throughout the service life of the machine. The old machine (still in use) had an original cost of $25,000 four years ago, and at the time it was purchased, its service life (physical life) was estimated to be seven years, with a salvage value of $5,000. The old machine has a current market value of $7,900. If the firm retains the old machine, its updated market values and operating costs for the next four years will be as follows:

Year-End	Market Value	Operating Costs
0	$7900
1	4300	$3200
2	3300	3700
3	1100	4800
4	0	5850

-The firm’s MARR is 12%.

-Both the old and the new machines have a CCA rate of 20%

-The marginal tax rate is 35%

(a) Working with the updated estimates of market values and operating costs over the next four years, determine the remaining useful life of the old machine. (b) Determine whether it is economical to make the replacement now.

Answer 1

defender:

MARR=12%

YEAR	OC	MV	AEOC	CR	AEC
0		7900
1	3200	4300	3200	4548	7748
2	3700	3300	3436	3118	6554
3	4800	1100	3840	2963	6803
4	5850	0	4261	2601	6862

The defender's economic life is two years with AEC = $6554.

Challenger:

MARR=12%

N=10

YEAR	0	1	2	3	4	5	6	7	8	9	10
REVENUE											-
Cost		-1000	-1000	-1000	-1000	-1000	-1000	-1000	-1000	-1000	1000
SV	-32000										2500
NET	-32000	-1000	-1000	-1000	-1000	-1000	-1000	-1000	-1000	-1000	1500
NPV	-$36845
AEC	$6521

Since the AEC of the defender is larger, so replace it now.