Problem 4 A company is considering replacing a painting machine purchased 9 year

Question

Problem 4 A company is considering replacing a painting machine purchased 9 years ago for $700,000. It has a market value today of $40,000. The unit costs $350,000 annually to operate and maintain. A new unit can be purchased for $800,000 and will have annual O&M; costs of $120,000. If the old unit is retained, it will have no salvage value at the end of its remaining life of 10 years. The new unit, if purchased, will have a salvage value of $100,000 in 10 years. Analyze this using an EUAC measure and a MARR of 20% to perform a before-tax analysis to see if the painting machine should be replaced if the old painting machine is taken in as a trade-in for its market value of $40,000 a. Use the cash flow approach (insider's viewpoint approach). b. Use the opportunity cost approach (outsider's viewpoint approach).

Explanation / Answer

Cash flow approach

If old unit is retained

Present value of O&M cost = O&M cost per year*Cummulative pv factor of 10 years of 20%

$350000*4.1924= $1467340

Salvage value = Nil

Total cash flow = -$1467340

If new machine is purchased

Intial cost of purchase = ($800000-$40000)= $760000

Present Value of O&M cost = $120000*4.1924 = $503088

Total outflow = $1263088

less; Inflow

Present value of salvage($100000*0.1938)= ($19380)

Net cash flow= -$1243708

Outflow is less in new machinery purchase. So option second shall be choose.

Opportunity cost method

If he choose second alternative then opportunity cost is $1467340.

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