Question 4 (25 marks) (a) You have purchased a machine costing $20,000. The mach
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Question 4 (25 marks) (a) You have purchased a machine costing $20,000. The machine will be used for 2 ycars, and at the end of the second year, the salvage value of the machine is expected to be $10,000. The expected annual net savings generated by the machine will be $30,000 during the first year and $40,000 during the second year. The machine will be used 6,000 hours during the first year and 8,000 hours during the second year. The interest rate is 10% i) Calculate the annual equivalent cost of capital of the machine. (3 marks) ii Calculate the annual equivalent of savings. (3 marks) ii) Calculate the annual equivalent net savings per machine hour. (5 marks) (b) An engineer planning to retire saves 5 equal annual deposits in a savings account that pays 6% per year, compounded annually. Suppose that the engineer wishes to make 5 withdrawals, with the first withdraw of $5,000 made at the end of year 6 and subsequent withdrawals increasing at a rate of 10% per year over the previous year's i What is the amount of the equal annual deposit? (7 marks) ii) What is the amount of the 5th withdrawal? (3 marks) (c) Consider the following cash flow diagram. Calculate the equivalent present worth of the cash flow series which have varying interest rates. (4 marks) $I00o 1000 3 PE?Explanation / Answer
Machine costing = $20,000
Duration = 2 years
Salvage Value = $10,000
Net Savings Year 1 = $30,000
Net Savings Year 2 = $40,000
Interest Rate = 10%
Machine Hours Year 1 = 6000
Machine Hours Year 2 = 8000
Using straight line depreciation method the depreciation per year of the machine is
= (Initial Cost – Salvage Value)/Duration
= (20,000 – 10,000)/2
= 5,000
(i) Instead of buying the machine, if the same amount is invested in market the return would have been in 1st year is 20,000*1.1 = 22,000, similarly in 2nd year it would have been 22,000*1.1 = 24,200.
But buying the machine the equivalent cost of capital is (30,000+40,000)/20,000 = 350%. So, it is a good decision to buy a machine where the return is 350% rather than investing it elsewhere at 10% interest rate.
(ii) The equivalent savings, net savings/ no. of years, (30,000 + 40,000 – 20,000)/2 = 50,000/2 = 25,000
(iii) Equivalent savings per machine hour = Total savings/Total Machine Hours = 50,000/14,000 = 3.57
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