## Replacement

1 a. The table below shows the operating cost and salvage value for a machine for a three-year period.
Find the economic life of the machine. The machine has an initial cost of \$50,000. The MARR for this analysis is 10%.

 Year Operating Cost Salvage Value 1 10,000 0 2 40,000 0 3 70,000 0

b. The table below shows the operating cost and salvage value for a machine for a three-year period.
Find the economic life of the machine. The machine has an initial cost of \$50,000. The MARR for this analysis is 10%.

 Year Operating Cost Salvage Value 1 10,000 30,000 2 10,000 20,000 3 10,000 0

2. An asset was purchased one year ago for \$100,000. The annual cost of operating the process is \$20,000. We expect the asset to last another 5 years and this operating cost will remain constant during that time.

During the year, a remarkable new process was discovered that uses waste material to run the process. The result is that the same output can be obtained with zero operating cost. The cost of purchasing and installing the new process is \$200,000. If we buy the new process we will keep it for ten years. It will have zero salvage at the end of this time. Note that under these conditions the economic life of the new process is ten years.

You must have either the new or old process. Both options perform the function with equal quality.

You are considering selling the year old process and replacing it with the new process. There is a buyer that is willing to take the old process off your hands for \$30,000 now. If you don't make the change now, you doubt that you will find a buyer for any price. After this year, you will have to pay \$10,000 to get rid of the old machine. The minimum acceptable rate of return is 10%.

a. What is the Net Annual Cost of the challenger?

b. What is the economic life of the defender?

c. What is the best decision?

3. An asset is purchased for \$14,000 with a six-year tax life. The sum-of-years digits method is used for depreciation. The tax salvage value is zero.

a. After the third year of use, the asset is sold for \$10,000. How much does the company get from the sale after taxes assuming the tax rate on capital gains is 40%?

b. Neglect taxes in this part. After the third year of life, we are considering replacing the machine with a new one. We could sell the machine now for \$10,000. Next year the machine will be worth \$6,000 and in two years it will be worth \$4000. Three years from now the machine will have no resale value. The operating cost of the machine will be constant for the next three years at \$1000 per year. The new machine has a life of ten years with a NAC of \$5000. Neglect taxes. Be sure to show all relevant calculations. The MARR is 10%. Should you replace the old machine with the new one?

4. You are considering replacing your car with a new one. After much bickering, the dealer offers you the new car for \$10,000 with your car as a trade-in or \$12,000 without your car. An acquaintance offers you \$3,500 for your car if you fix the air conditioner. That will cost you \$1,000. The expected maintenance cost of your car for the next year is \$1200 not including the air conditioner. You think you can sell your car for \$1,000 at this time next year without fixing the air conditioner.

Assume that the life of the new car is 10 years with annual maintenance cost of \$800 per year. The new car will have \$2,000 salvage value at the end of the 10 years. Show the cash flows you would use in an analysis. Your minimum acceptable rate of return is 10%. What is your most economic action?

5. A company faces the following equipment replacement problem. An existing piece of equipment is 4 years old and was originally bought for \$8,000. The economic life of this equipment is 8 years and it has no salvage at the end of its useful life. The machine has been depreciated by the straight line method and its current market value is equal to its book value. If the machine is replaced, \$500 must be spent to remove it and ready it for sale. Neglect any tax effects associated with the sale or removal costs. The net annual before tax benefit of \$2,000 from the existing equipment is expected to continue for another four years. Use four years as the economic life, and assume the salvage value is zero at the end of four years.

The new machine being considered as a replacement costs \$10,000. It has an economic life of 10 years at the end of which it can be sold for \$2,000. The net annual before tax benefit expected from this machine is \$3,000. Again the straight-line method is used for depreciation using a tax salvage of \$2000.

The tax rate is given to be 50%. The after tax minimum acceptable rate of return is 10%.

Should you replace the existing machine with a new one?

6. You are to decide on a cost basis whether to keep an existing machine or replace it with a new one. A milling machine (machine A) in a job shop has a current market value of \$30,000. It was bought nine years ago for \$54,000 and has since been depreciated by the straight-line method assuming a 12 year tax life. If we decide to keep the machine at this point it time we expect it to last another 12 years (measured from today). At the end of the 12 years it will be worthless. The operating costs of this machine are \$7,500 per year and are not expected to change for the remaining life of the machine.

Machine A can now be replaced by a smaller machine B. Machine B costs \$42,000 and has an anticipated life of 12 years. Its operating costs are \$5,000 per year. It would be depreciated by the straight-line method with a 12 year depreciable life and no salvage value.

Both the income tax and capital gains tax rates are 40%. Compare the after tax equivalent uniform annual costs of the two machines and decide whether machine A should be retained or replaced by machine B. Use a 10% after tax rate of return in your calculations.