- 16 Marks
FM – L2 – Q65 – DCF: Specific applications
Calculate the equivalent annual cost for replacing a machine every 1, 2, 3, and 4 years and recommend the optimal replacement policy.
Question
A business entity, Volta Ventures, is considering its policy for the replacement of machines. One type of machine in regular use is Machine Y. This machine has a maximum useful life of four years, but maintenance costs and other running costs rise with use. An estimate of costs and disposal values is as follows:
Machine Y: Purchase cost GH₵40,000
| Year | Maintenance costs and other running costs in the year | Disposal value at the end of the year |
|---|---|---|
| GH₵ | GH₵ | |
| 1 | 8,000 | 25,000 |
| 2 | 12,000 | 20,000 |
| 3 | 20,000 | 10,000 |
| 4 | 25,000 | 0 |
The cost of capital is 10%.
Required
Calculate the equivalent annual cost of a replacement policy for the machine of replacement:
(a) every one year
(b) every two years
(c) every three years
(d) every four years.
Recommend a replacement policy for the machine.
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