Chapter 11_Replacement and Retention Decisions A lumber company that cuts fine w

Question

Chapter 11_Replacement and Retention Decisions A lumber company that cuts fine woods for cabinetry is evaluating whether it should retain the current bleaching system or replace it with a new one. The relevant costs for each system are known or estimated. Use an interest rate of 10% per year to (a) perform the replacement analysis and (b) determine the minimum resale price needed to make the challenger replacement choice now. Is this a reasonable amount to expect for the current system? Current New System System First cost 7 years ago, $ –450,000 First cost, $ –700,000 Remaining life, years 5 10 Current market value, $ 50,000 AOC, $ per year –160,000 –150,000 Future salvage, $ 0 50,000

Explanation / Answer

a) AWcurr = -50,000(A/P,10%,5) -160,000

= -50,000(0.2638) - 160,000

= -173190

AWnew = -700,000(A/P,10%,10) -150,000 + 500,000(A/F,10%,10)

= -700,000(0.16275) -150,000 +500,000(0.06275)

= -260,788

It is better to continue current system for 5 years as the AW is more positive compared to new system.

b)

-260788 = M(A/P,10%,5) - 160,000

-260788 = 0.2368M -160,000

M = -382,060

Not reasonable since the current system has been used for more than half of its service life ( 7 of 12 years) and after 60% of its service life ,the price should not be 85% of the original cost.

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