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Selecting Among Alternative Equipment

1. You currently have a piece of equipment that is 2 years old and cost $13,000 when it was new. It has five years left on it's economic life and can be traded in for $8,000. It will have annual operating cost of $4,000. A new piece of equipment can be purchased for $18,000 and will have annual operating cost of $1,000. This new equipment will have an economic life of 6 years. Should you keep the old equipment or buy the new equipment?

2. Two electrical systems are being compared for a new industrial plant. The one system will have first cost of $200,000 and annual operating costs of $10,000. The second system will have first cost of $300,000 and annual operating costs of $5,000. Each system will be depreciated over a period 10 years using straight depreciation. The company is in a 35% tax bracket. Which system should be selected if they both help produce the same expected profits over the life of the investment?

Solution Preview

Please see the attached Excel File.

1. You currently have a piece of equipment that is 2 years old and cost $13,000 when it was new. It has five years left on it's economic life and can be traded in for $8,000. It will have annual operating cost of $4,000. A new piece of equipment can be purchased for $18,000 and will have annual operating cost of $1,000. This new equipment will have an economic life of 6 years. Should you keep the old equipment or buy the new equipment?

The required rate of return / cost of capital is not specified in the problem. We will work with 10 % to illustrate the problem.

Since the lives are unequal, we calculate the equivalent annual costs of the two equipments
The equipment with the lower Equivalent Annual Cost would be selected

We need to calculate or read from the tables PVIFA (r%,n) - Present Value of $1 for r%, n years

r= 10%
Old equipment
Since it can be traded for $8,000 now
Procurement Cost = $8,000
Life= 5 years
Annual operating cost= $4,000

Let us calculate its Equivalent Annual Cost
PVIFA( 10.% , 5 years ) = 3.7908

Present value of ...

Solution Summary

This solution discusses selecting between alternative investments using present value of costs.

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