Deck 14: Replacement Decisions

Question 1

Five years ago, a conveyor system was installed in a manufacturing plant at a cost of $35,000. It was estimated
that the system, which is still in operating condition, would have a useful life of eight years, with a salvage
value of $3,000. If the firm continues to operate the system, the system's estimated market values and operating
costs for the next three years are as follows: A new system can be installed for $43,500. This system would have an estimated economic life of 10 years, with
a salvage value of $3,500. The operating costs for the new system are expected to be $1,500 per year throughout
its service life. The firm's MARR is 18%. The system belongs to the seven-year MACRS property class. The firm
's marginal tax rate is 35%.
(a) Should the existing system be replaced?
(b) If the decision in (a) is to replace the existing system, when should replacement occur?

Answer 1

(b) Optimal time to replace (marginal analysis): Since the remaining useful life for the defender is 3 years,
which is the same as the physical life, keep the defender for 3 years.

Question 2

A manufacturing company is considering replacing a broken metal cutting machine. Several options have been
proposed.
· Option 1: The broken machine can be sold today for $2,500.
· Option 2: It can be overhauled completely for $8,000, after which it will produce$3,000 in annual cash flows
over the next five years. The resale value of the asset at the end of five years is zero.
· Option 3: It can be replaced for $20,000. The life of the replacement machine is five years, and it has an
estimated salvage value of $3,000 at the end of five years. The anticipated operating cash flows for each year
will be $6,000.
If the firm's required rate of return of 15%, what should the company do?

Answer 2

Question 3

A special-purpose machine is to be purchased at a cost of $30,000. The following table shows the expected
annual operating and maintenance cost and the salvage value for each year of service: If the interest rate is 12%, what is the economic service life for this machine?

Answer 3

Question 4

Eight years ago, a firm purchased a lathe for $45,000. The operating expenses for the lathe are $8,700 per year.
An equipment vendor offers the firm a new machine for $53,500. An allowance of $8,500 would be made for the
old machine on the purchase of the new one. The old machine is expected to be scrapped at the end of five
years.
The new machine's economic service life is five years, with a salvage value of $12,000. The new machine's O&M
cost is estimated to be $4,200 for the first year, increasing at an annual rate of $500 thereafter. The firm's MARR
is 12%. Which option would you recommend?

Question 5

A manufacturer is considering the replacement of one of its boring machines with a newer and more efficient
one. The relevant details for both defender and challenger are as follows:
· Old machine: The current book value of the old boring machine is $60,000, and it has a remaining useful
life of five years. The salvage value expected from scrapping the old machine at the end of five years is zero, but
the company can sell the machine now to another firm in the industry for $13,000.
· New Machine: The new boring machine can be purchased at a price of $144,000 and has an estimated
useful life of seven years. It has an estimated salvage value of $40,000 and is expected to realize economic
savings on electric-power usage, labor, and repair costs and to reduce the amount of reworks. In total, annual
savings of $60,000 will be realized if the new machine is installed.
The firm uses a MARR of 15%. Using the opportunity-cost approach, address the following questions:
(a) What is the initial cash outlay required for the new machine?
(b) What are the cash flows for the defender in years zero to five?
(c) Should the firm purchase the new machine?