Please show all work Esteez Construction Company has an overhead crane that has
ID: 1193013 • Letter: P
Question
Please show all work
Esteez Construction Company has an overhead crane that has an estimated remaining life of 7 years. The crane can be sold for $14,000. If the crane is kept in service it must be overhauled immediately at a cost of $6,000. Operating and maintenance costs will be $5,000/year after the crane is overhauled. After overhauling it, the crane will have a zero salvage value at the end of the 7-year period. A new crane will cost $36,000, will last for 7 years, and will have a $8000 salvage value at that time. Operating and maintenance costs are $2,500 for the new crane. Esteez uses an interest rate of 15% in evaluating investment alternatives. Should the company buy the new crane based upon an annual cost analysis?
Use the opportunity cost approach.
Explanation / Answer
Note: In cash flow analysis, we shall exclude depreciation since it is is a non-cash expense.
Existing Crane
Initial cost = $6,000 + $14,000 (Opportunity cost foregone by not selling the crane) = $20,000
Annual operating costs = $5,000
Salvage value = 0
New Crane
Initial cost = $36,000
Annual operating costs = $2,500
Salvage value = $8,000
Incremental costs:
Incremental initial cost = $(36,000 - 20,000) = $16,000
Incremental annual operating costs = $(2,500 - 5,000) = - $2,500
This is incremental annual benefit.
Incremental salvage value = $8,000
Therefore,
Incremental present worth = - $16,000 + $2,500 x Present value interest factor of annuity, PVIFA (15%, 7 years) + $8,000 / (1.15)7
= - $16,000 + $2,500 x 4.1604 [From PVIFA Table] + $3,007
= - $12,993 + $10,401
= - $2,592
Since incremental present worth < 0, the new crane should not be purchased.
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