An old covered bridge can be strengthened at a cost of $9000, or can be replaced
ID: 1096987 • Letter: A
Question
An old covered bridge can be strengthened at a cost of $9000, or can be replaced for $40,000. The present salvage value of the old bridge is $13,000. With reinforcements, it will last for an additional 20 years with $500 annual maintenance and have a salvage value at that time of $1000. The new bridge has a service life of 25 years and would bring $15000 salvage at that time and will reduce annual maintenance by $400 over the old bridge.
a) If the cost of money is 8%, should the bridge be replaced?
b) What is the break even cost of money between these two projects?
Explanation / Answer
Cash outflow of old machine=9000+PV of Annuity of 500 for 20years-PV of Salvage Value 1000 on 20th Year Cash outflow of old machine=9000+9.818*500-1000*0.215 13694 Cash oufFlow of new Machine=(40000-13000)+PV of annuity 100 over 25years-PV of salvage Value of 15000 on 25th year Cash outflow of new Machine=(40000-13000)+10.675*100-15000*0.146 25878 Since the cash outflow in case of oldbridge is less , we should strengthen it and should not replace it.