Question

Time allowance: 15 minutes) You are considering replacing an existing (old) machine with a new machine: either machine A or machine B. Machine A has an 5 year life, and an NPV of $39,640; while machine B has a 10 year life and an NPV of $54,940. The old machine can be sold (market value) today for $4,000. The old machine is depreciated down to zero using straight line, the annual depreciation is $2,000 and the remaining book value today for the old machine is $6,000. If you decide to postpone, the annual pre-tax maintenance and operations expenses are $8,000. In addition, if the old machine is replaced next year instead of today, it could be sold for $3,000 then (market value in year 1 ). The tax rate is 25%. The discounting rate is 10%. In answering the questions that are answers in dollars, enter your answer en millions of dollars and use/round to two decimals, and do not use the dollar ( $ ) sign. For example if your answer is $12,500,340 then enter 12.50; if answer is $537,459 then enter 0.54 ; if the answer is $40,000,000 then enter 40.00

Answer 1

To determine the method with the lowest cost, consider the cost of machines and labor. Method 3 should be chosen as it has the lowest total cost.

Step-by-step explanation:

To determine the total cost of the three methods, you need to consider the cost of machines and labor. If the cost of machines increases to $55 and the cost of labor stays at $40, the total cost for each method can be calculated as follows:

• Method 1: 10 x $55 (machines) + 3 x $40 (labor) = $550 (machines) + $120 (labor) = $670
• Method 2: 7 x $55 (machines) + 3 x $40 (labor) = $385 (machines) + $120 (labor) = $505
• Method 3: 3 x $55 (machines) + 3 x $40 (labor) = $165 (machines) + $120 (labor) = $285

Based on the new total cost, the firm should choose Method 3, as it has the lowest cost of $285.