IR. Cameo Inc, a PA based construction firm is evaluating whether to replace an

Question

IR. Cameo Inc, a PA based construction firm is evaluating whether to replace an aging backhoe with a new model.

For the old backhoe next year, maintenance will cost $1,500, and these costs will double each year. The old backhoe could be sold today for $4,000, but resale value will decline 50% each year.

A new model costs $12,000, lasts for 5 years and costs $900/year to maintain. After 5 years the new model could be sold for $1,500.

If r=12%, and we ignore taxes, should IR replace the old backhoe? If so, when should it do it?

Explanation / Answer

They should resell it after one year for the new model. $4000/2(value decline) - $1500 = $500 If they were to wait another year it would be $4000/4(value decline) - $1500 = -$500 I would sell it after the first year. Hope this helps, best of luck.

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