Company X has been contracting its overhauling work to Company Y for $41,000 per
ID: 2794508 • Letter: C
Question
Company X has been contracting its overhauling work to Company Y for $41,000 per machine per year. Company X estimates that by building a $565,000 maintenance facility with a life of 17 years and a salvage value of $68,000 at the end of its life, it could handle its own overhauling at a cost of only $20,000 per machine per year. What is the minimum annual number of machines (as an integer) that Company X must operate to make it economically feasible to build its own facility? (Assume an interest rate of 11%.) Hint: calculate the annual equivalent cost of the maintenance facility.
Explanation / Answer
Annual savings in overhauling cost = 41000-20000 = $ 21000 per machine per year
Present value of annual savings =[PVA 11% ,17 * Annual savings ]+[PVF 11%,17*salvage]
= [7.54879*21000]+ [.16963*68000]
= $ 158,524.59 + 11534.84
= 170059.43 per machine
Let x be the number of machines to be indifferent.
At indifference point =Initial cost equals present value of annual savings
565000 = 170059.43*X
x = 565000/170059.43
= 3.32 [approx to 4 machines ]
minimum annual number of machines =4 or more
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