State-of-the-art digital imaging equipment pur­chased 2 years ago for $50,000 had an expected useful life of 5 years and a $5000 salvage value. After its installation the performance was poor, and it was upgraded for $20,000 one year ago. Increased demand now requires another upgrade for an additional $22,000 so that it can be used for 3 more years. Its new annual operating cost will be $27,000 with a $12,000 salvage after the 3 years. Alternatively, it can be replaced with new equipment costing $65,000, an estimated AOC of $14,000, and an expected salvage of $23,000 after 3 years. If replaced now, the exist­ing equipment can be traded for only $7000. Use a MARR of 10% per year. (a) Determine whether the company should retain or replace the de­fender now. (b) Based on the poor

Question

experience with the current equipment, assume the person doing this analysis decides the challenger may be kept for only 2 years, not 3, with the same AOC and salvage estimates for the 2 years. What is the decision?

What will be an ideal response?

Answer 1

(a) AWD = -(7000 + 22,000)(A/P,10%,3) – 27,000 + 12,000(A/F,10%,3)
= -29,000(0.40211) – 27,000 + 12,000(0.30211)
= $-35,036

AWC = -65,000(A/P,10%,3) – 14,000 + 23,000(A/F,10%,3)
= -65,000(0.40211) – 14,000 + 23,000(0.30211)
= $-33,189
Replace the defender with the challenger

(b) Find AWC over 2 years and compare with AWD over 3 years

AWC = -65,000(A/P,10%,2) – 14,000 + 23,000(A/F,10%,2)
= -65,000(0.57619) – 14,000 + 23,000(0.47619)
= $-40,500
Now AWC > AWD; retain the defender