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Calculation Of Optimal Replacement Cycle For New Machine

Question

Gillian is deciding whether to replace an old machine, and has assembled the following information:

 

Old Machine

New Machine

Life at purchase:

3 years

3 years

Remaining life:

1 year

3 years

Cost at purchase:

$9,000

$12,000

Depreciation (p.a.):

$3,000

$4,000

Revenue (p.a.)

$6,000

$7,000

Expenses-

year 1

year 2

year 3

$2,000

$1,000
$1,500
$2,250

Salvage Value

Book Value

Book Value

 

She believes that the second-hand market value of either machine will decline over time in line with the depreciation schedule (for example, the old machine should sell for $3,000 today). If there are no taxes, and Gillian’s required rate of return is 15% p.a.:

i) What is the optimal replacement cycle for the new machine?

ii) Should the old machine be replaced now, or next year?

(Note: If you are unable to complete part (i), state any necessary assumptions and then complete part (ii).)

 

Summary

The question belongs to Finance and it discusses about calculation of optimal replacement cycle for new machine and when should the old machine be replaced.

Total Word Count 231

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Comments

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