kindly help me to solve this question. 07. A construction company has purchased
ID: 1124347 • Letter: K
Question
kindly help me to solve this question.
07. A construction company has purchased a piece of construction equipment 3 years ago at a cost of Rs.4000000. The estimated life and salvage value at the time of purchase were 12 years and Rs.850000 respectively. The annual operating and maintenance cost was Rs.150000. The construction company is now considering replacement of the existing equipment with a new model available in the market. Due to depreciation, the current book value of the existing equipment is Rs.3055000. The current market value of the existing equipment is Rs.2950000. The revised estimate of salvage value and remaining life are Rs.650000 and 8 years respectively. The annual operating and maintenance cost is same as carlier i.e. Rs.150000. The initial cost of the new model is Rs.3500000. The estimated life, salvage value and annual operating and maintenance cost are g years, Rs.9(1000 and Rs 125000 respectively. Company's MARR is 10% per year. Find out whether the construction company should retain the ownership of the existing equipment or replace it with the new model. if study period is taken as 8 years (considering equal life of both defender and challenger).Explanation / Answer
ANSWER:
IN ORDER TO ANALYZE THE REPLACEMENT THE INITIAL COST OF 4000000 , INITIAL ESTIMATE OF SALVAGE VALUE OF 8500000 AND THE REMAINING LIFE OF 9 (12 -3 ) YEARS AND THE CURRENT BOOK VALUE OF THE EXISTING EQUIPMENT WHICH IS 3055000 ARE NOT IMPORTANT.
THE SUNK COST WHICH IS (3055000 - 2950000) 105000 IS ALSO NOT IMPORTANT.
FOR DEFENDER:
CURRENT MARKET VALUE IS 2950000 AND SALVAGE VALUE OF 6500000.
ANNUAL OPERATING AND MAINTENANCE COST IS 150000 AND N IS 8 YEARS.
FOR CHALLENGER:
INITIAL COST OF 3500000 AND SALVAGE VALUE OF 900000.
ANNUAL OPERATING AND MAINTENANCE COST IS 125000 AND N IS 8 YEARS.
AW OF DEFENDER = -2950000(A/P,I,N) -150000 + 650000(A/F,I,N)
AW OF DEFENDER = -2950000(A/P,10%,8) -150000 + 650000(A/F,10%,8)
AW OF DEFENDER = (-2950000 * 0.1874) - 150000 + (650000 * 0.0874)
AW OF DEFENDER = -646020
FOR CHALLENGER:
AW OF CHALLENGER = -3500000(A/P,I,N) -125000 +900000(A/F,I,N)
AW OF CHALLENGER = -3500000(A/P,10%,8) -125000 +900000(A/F,10%,8)
AW OF CHALLENGER = (-3500000 * 0.1874) -125000 + (900000 * 0.0874)
AW OF CHALLENGER = -702240
SINCE THE EQUIAVALENT UNIFORM COST OF THE DEFENDER IS LESS THEN THAT OF CHALLENGER AND THEREFORE THE COMPANY SHOULD RETAIN THE DEFENDER.
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