Five years ago, Thomas Martin installed production machinery that had a first co
ID: 2600485 • Letter: F
Question
Five years ago, Thomas Martin installed production machinery that had a first cost of $25,000. At that time initial yearly costs were estimated at $1,250, increasing by $500 each year. The market value of this machinery each year would be 90% of the previous year's value. There is a new machine available now that has a first cost of $27,900 and no yearly costs over its five-year minimum cost life. If Thomas Martin uses an 8% before-tax MARR, when, if at all, should he replace the existing machinery with the new unit?Explanation / Answer
Answer:
First of all we need to find out the present value of old machinery and initial cash out flow
present value of old machinery
=25,000*(90%)* 5
=14762.25
Now we will find initial cash out flow
Cost of new machinery
27900
Less:
Resale value of existing machine
14762.25
Initial cash out flow
13137.75
It was given in the question that, at that time initial yearly costs were estimated at $1250, increasing by $500 each year. so current it passed 5 year of installing old machine and for the current year the exposes will be
Year
Cost
Calculating
1
1250
1250
Cost for each five
years for old machine
2
1750
1250+500
3
2250
1750+500
4
2750
2250+500
5
3250
3750+500
6
3750
3250+500
Cost that will be saves it installed new machine
4
4250
3750+500
8
4750
4250+500
9
5250
4750+500
10
5750
5250+500
Now we will find NPV as under
Year
Cash
flow
PV
factor at 8%
Present
value
0
-13137.75
1
-13137.75
1
3750
0.926
3472.5
2
4250
0.851
3616.75
3
4750
0.794
3771.5
4
5250
0.735
3858.75
5
5750
0.681
3915.75
NPV
5497.5
Conclusion :
As NPV of the new machine is $5497.5 positive so company should replace the machinery now
Cost of new machinery
27900
Less:
Resale value of existing machine
14762.25
Initial cash out flow
13137.75
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