Searching for ways to cut costs and increase profit, one of the industrial engineers at Home Comfort Furniture Manufacturers, Inc. determined that the equivalent annual worth of an existing machine over its remaining useful life of 2 years is $70,000 per year. The IE also determined that used machines like the one currently in use are not available any longer, but the defender can be replaced with a challenger that is more advanced. It will have an AW of $80,000 if it is kept for 2 years or less, $75,000 if it is kept between 3 and 4 years, and $65,000 if it is kept for 5 to 10 years. If the company uses a specified 3-year planning horizon and an interest rate of 15% per year, determine (a) when the company should replace the machine, and (b) the AW for the next 3 years.
What will be an ideal response?
(a) Option 1: Keep defender for 2 years and then replace it with challenger for 1 year
AW1 = -70,000 – (80,000 – 70,000)(A/F,15%,3)
= -70,000 – 10,000(0.28798)
= $-72,880
Option 2: Replace now with challenger for all 3 years
AW2 = $-75,000
Keep the machine 2 years and then replace with the challenger
(b) The annual worth will be AW1 = $-72,880
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