A small manufacturing firm is considering the purchase of a new machine to moder

Question

A small manufacturing firm is considering the purchase of a new machine to modernize one of its current production lines. Two types of machines are available on the market. The lives of Machine A and Machine B are four years and six years respectively, but the firm does not expect to need the service of either machine for more than five years. The machines have the following expected receipts and disbursements: item Machine A Machine B Initial cost $ 6,500 $ 8,500 Service Life 4 years 6 years Estimated salvage value $ 600 at the end $ 900 at the end of 4 years of6 years Annual O & M costs $ 800 $ 520 After five years of use, the salvage value for Machine B will be $ 1,000. The firm always has another option: to lease a machine at $ 3,000 per year, fully maintained by the leasing company. The lease payment will be made at the beginning of each year. (a) How many decision alternatives are there? (b) Which decision is the best, at MARR = 10 %, compounded annually, based on the data given?

Explanation / Answer

a. There are two decision alternatives

Either opt for Machine A which will work for 4 yrs, then opt for lease at $3000 for the fifith year

Or

Opt for machine B then use it for 5 yrs and sale it at salvage value

b. Case1

Year 1 outflow = $6500

Year 1-4 outflow =$800

Year 4 inflow = $600

Year 5 outflow =$3000

Thus present outflow at 10% discount = $10488.88

Case 2

Initial outflow = $8500

Year 1-5 outflow = $520

Year 5 inflow = $1000

Thus present outflow at 10% discount = $9850.28

Thus Case 2 is the best

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