PROBLEMS ON INVESTMENT ANALYSIS / LIFE CYCLE COSTING - V

Q 1. A proposed improvement in an assembly line will have an initial purchase and

installation cost of $ 67,000. Annual maintenance cost will be $ 3500; periodic overhauls
once every 3 years will cost $ 6000 each. The improvement will have a useful life of 12
years at which time it will have no salvage value. What is the equivalent annual expense of
the lifetime costs of the improvement when annual interest rate is 8%?

Q 2. The management is considering whether or not to replace an existing machine with a

new design. The existing machine has no market value. The new machine costs $10,000
initially and has an eight years projected economic life with no terminal salvage value (at
the end of depreciation term). The company is in 50% tax bracket and 20% is considered as
the minimum rate of return. Allowed depreciation term is 10 years, straight line. Determine
if the company should install the new machine.
Use NPV (net present value) or POP/PBP (pay-off / pay-back period) criteria.

Comparative operating costs old m/c new m/c

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Direct labour $9500/yr $4000/yr
Wasted material $500/yr $400/yr
Power cost $1000/yr $900/yr

Assume the remaining life of the old machine as 8 years.

Q 3. An equipment is purchased for Rs 50,000 that will reduce the materials and labour
cost by Rs 14,000 each year for N years. After N years, there will be no need for the
equipment and since it is specially designed, it will have no salvage value at any time.
However, according to the Company’s tax procedure, this equipment must be depreciated
on a straight line basis for the tax life (depreciation term) of 5 years. If the tax rate is 50%,
what is the minimum number of years (that is N) that the Company must operate the
equipment to earn a minimum 10% after-tax-return ?
(First draw cash flow diagrams).