2. A small construction company owns a generator which was purchased for $11 ,00
ID: 1096510 • Letter: 2
Question
2. A small construction company owns a generator which was purchased for $11 ,000 three years ago. Its current salvage value is $2400 and that s expected to fall to $1400 next year, $980 the following year and subsequently decline by 30% per annum. Operating and maintenance is now $1000 pa. and expected to risc by $500 p.a. There is also a need for a $1000 overhaul this year and every third year subsequently. The best available new generator would cost the company $9500.00; and other data for the new generator are summarized below. MAR.R is 12%. (a) Find the economic life and the minimum AEC of the new generator. (b) Find the economic life and the minimum AEC of the existing generator. (c) Should the new generator be purchased today? Salvage Values and Operating Costs for New GeneratorExplanation / Answer
(a) Statement showing calculation of economic life and
minimum AEC of new generator
Operating
Cost
Cumulating
Operating
Cost
Depreciation
(cumulative)
Total
Cost
Average
Annual
Cost
Details: Calculation procedure of above table are explained below-
1. Three costs are considered here. First one is operating cost. Yearly operating cost is shown in column 3. Cumulative figures are shown in the next column (i.e. column 4).
2. Column five indicates total depreciation of the generator. It has been calculated by deducting cost of the generator in the year under consideration (column 2) from initial cost of it at time 0. Suppose you are calculating cumulative depreciation of year 3. In year 3 cost of the machine is $6,000. Cost at time '0' was $9,500. Therefore cumulative depreciatio of three years is $9,500-$6,000=$3,500.
3. Add cumulative operating cost (colum 4) and cumulative depreciation (column 5) to get totalcost at column 6.
4. Finally divide total cost by the number of years to get average cost per annum. Note that average cost is falling till 3rd year. After 3rd year it has started moving up. Thus economic life should be 3 years. It is the period when average cost is minimum. AEC is the average cost of 3rd year as it is the lowest one.
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Result:
1. Economic life is 3 years since average annual cost is lowest here. After 3rd year it is going up.
2. AEC is $2,233
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(b) Calculation of economic life and AEC of old generator
Operating
cost
Cum.
Operating
cost
Overhaul
Cost
Cum.
Overhaul cost
Cum.
Depreciation
Average
Cost
Explanation: Same method has been applied here. Additional cost of existing generator is overhauling cost. THus total cost is the sum of cumulative depreciation cost plus cumulative operating cost plus cumulative overhauling cost
Result:
1. Economic life of existing generator is 3 years.
2. AEC of existing generator is $2,405
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(c) Remarks: Both old and new generator have same economic life of three years. But average annual cost of existing generator is more than the annual average cost of new generator. Hence old generator should be replaced now.
Year CostOperating
Cost
Cumulating
Operating
Cost
Depreciation
(cumulative)
Total
Cost
Average
Annual
Cost
(1) (2) (3) (4) (5) (6) (7) 0 9,500 0 0 0 - 1 8,000 1,000 1,000 1,500 2,500 2,500 2 7,000 1,000 2,000 2,500 4,500 2,250 3 6,000 1,200 3,200 3,500 6,700 2,233 4 5,000 1,500 4,700 4,500 9,200 2,300 5 4,000 2,000 6,700 5,500 12,200 2,440 6 3,000 2,000 8,700 6,500 15,200 2,533 7 2,000 2,000 10,700 7,500 18,200 2,600 8 1,000 3,000 13,700 8,500 22,200 2,778Related Questions
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