A machine purchased 3 years ago for $140,000 is now too slow to satisfy the demand of customers. It can be upgraded now for $79,000 or sold to a smaller company internationally for $40,000. The upgraded machine will have an annual operating cost of $85,000 per year and a $30,000 salvage value in 3 years. If upgraded, the presently owned machine will be retained for only 3 more years, then replaced with a machine to be used in the manufacture of several other product lines. The re­placement machine, which will serve the company now and for a maximum of 8 years, costs $220,000. Its salvage value will be $50,000 for years 1 through 5; $20,000 after 6 years; and $10,000 thereafter. It will have an estimated operating cost of $45,000 per year.

Question

Your boss asks you to perform an economic analysis at 15% per year using a specified 3-year planning horizon (a) to determine if the current machine should be replaced now or 3 years from now, and (b) once decided, to determine the equiv­alent AW for the next 3 years. (c) Write the spread­sheet functions that determine the AW values.
(d ) After you return to your office, your boss texts the following question and wants an answer immediately. What do you tell her and what is the spreadsheet function used to determine the an­swer? “Hi, what is the equivalent annual worth of the replacement machine if we keep it for its maxi­mum expected life and how much does this reduce the capital recovery each year?”

Answer 1

(a) Two options; (1) upgrade and retain defender for 3 years, or (2) buy challenger now
AW1 = - (40,000 + 79,000)(A/P,15%,3) – 85,000 + 30,000(A/F,15%,3)
= -119,000(0.43798) – 85,000 + 30,000(0.28798)
= $-128,480

AW2 = -220,000(A/P,15%,3) – 45,000 + 50,000(A/F,15%,3)
= -220,000(0.43798) – 45,000 + 50,000(0.28798)
= $-126,957

Select option 2; replace the defender now
(b) AW2 = $-126,957 for 3 years

(c) AW1 function: = -PMT(15%,3,-119000,30000) - 85000
AW2 function: = -PMT(15%,3,-220000,50000) – 45000

(d) AW2 function for 8 years: = -PMT(15%,8,-220000,10000) – 45000

The display is AW2 = $-93,299. This is a reduction of $33,658 per year in capital
recovery from the AW amount of $-126,957over the 3-year study period in (a).

(Note: This amount is correct since the AOC is constant at $45,000 per year
regardless of the number of years in service.)