Question

Smash’n has an ageing piece of equipment which is less efficient than more modern equivalents. This equipment will continue to operate for another 15 years but operating and maintenance costs will be NOK35,000 per year. Alternatively, it could be sold, raising NOK20,000 now and replace with its modern equivalent which costs NOK 70,000 but has reduced operating and maintenance costs at NOK 30,000 per year. This machine could be sold at the end of its 15-year life for scrap for NOK 5,000. The third possibility is to spend NOK 25,000 for an immediate overhaul of the old machine which will improve its efficiency for the rest of its life, so that operating and maintenance costs become NOK 32,000 per annum. The old machine will have a zero scrap value in 15 years, whether or not it is overhauled. Smash’n requires a return of 9% on projects in this risk class. What is the best course of action? Assume that cash flows arise at the year ends.

Can you please show how to find the answer step by step.

Answer 1

Step By Step Answer:-

Calculation of the Intial cost :-

In old machinery which doesn't require the repair hence it is having 0 initial cost.

In new machinery total require the cost of 70,000 and we will sold the old machinery at 20,000 so the net initial cash outflow = 50,000.

In old machinery which requires the repair of 25000 have the initial cash outflow of 25000.

Formula Used for calculating the present Value:-

Present Value of Cost=PV(9%,15,-U88,U87)+U86

(Drag the formula in other cells).

Final answer:-

We will choose to use old machinery without repair it, because it have lowest present value of cost.