The plant manager has asked you to do a cost anal­ysis to determine when currently owned equip­ment should be replaced. The manager stated that under no circumstances will the existing equip­ment be retained longer than two more years and that once it is replaced, a contractor will provide the same service from then on at a cost of $97,000 per year. The salvage value of the currently owned equipment is estimated to be $37,000 now, $30,000 in 1 year, and $19,000 two years from now. The operating cost is expected to be $85,000 per year. Using an interest rate of 10% per year, determine when the defending equipment should be retired.

Question

What will be an ideal response?

Answer 1

Find defender ESL; compare with AWC = $-97,000

AWD,1 = -37,000(A/P,10%,1) – 85,000 + 30,000(A/F,10%,1) –
= -37,000(1.10) – 85,000 + 30,000(1.000)
= $-95,700

AWD,2 = -37,000(A/P,10%,2) – 85,000 + 19,000(A/F,10%,2)
= -37,000(0.57619) – 85,000 + 19,000(0.47619)
= $-97,271

Defender ESL is n = 1 year with AWD = $-95,700
Keep equipment one year and then replace with contractor