PROBLEMS ON INVESTMENT ANALYSIS / LIFE CYCLE COSTING - VII

1. Consider the following data for two machines A & B

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machine initial cost annual operating costs salvage value
(After 5 yrs. / 20 yrs.)
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A 25,000 4,000 0
B 15,000 8,000 0
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The machines can be used for 5 years, or they can be retained for use after the 5th year. If
so, the total useful life will be 20 years. The company is permitted to write-off the machines
in 5 years for tax purposes, or it can write-off the machines in 20 years.

Compare the results (which machine is more economical) of using the long-term (20 years)
or short-term (5 years) write-off periods if the tax rate is 50% and sum of years digits (SYD)
method is used for depreciation. Assume interest rate of 10%.
(Consider 5 years’ write-off period only for this practice session)

Assume that the machines are of same capacity and result in same annual gross profit = x.

2. Assume the initial investment of an asset as Rs 100,000, and salvage value of Rs

10,000 with the life of the asset as 10 years.

Consider the following three methods of depreciation:

i) Straight line ii) SYD iii) Declining balance method (DBM)

For these methods, plot the profile of undepreciated balance (UB) / salvage value (SV) as a
function of life. Assuming interest rate of 15%, compute the net present worth of cash flows
if above methods of depreciation are used. Assume that incremental tax rate is 50%.

Also rank the above depreciation methods.