Five years ago, Thomas Martin installed production machinery that had a first co
ID: 2754816 • 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
Current Market value of existing machinery = $25000 *(0.90)^5 = $ 14,762.25
Cost of new machinery = $ 27,900
Calculation of Present value of net cash outflow
Cost of new machinery = $ 27,900.00
Less: resale value of existing machinery = $ (14762.25)
Present value of net cash outflow = $ 13137.75
Present value of cash inflow (Saving in expenses)
Year Expenses Saved ($) PVF at 8% Present value ($)
1 3750 0.926 3472.50
2 4250 0.851 3616.75
3 4750 0.794 3771.50
4 5250 0.735 3858.75
5 5750 0.681 3915.75
18635.25
i.e if we replace the machinery, we would be able to save yearly expenses amlounting to $ 18635.25 (Present value)
Accordingly,
Present value of cash outflow = ($ 13137.75)
Present value of expenses saved = $ 18635.25
Net present value (benefit) = $ 5497.50
Thus, it's beneficial to replace the machinery now.
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