Please show work. This was a two part question had to break it up. Hope someone
ID: 1193472 • Letter: P
Question
Please show work. This was a two part question had to break it up. Hope someone can solve this. Thanks in advance.
Esteez Construction Company has an overhead crane that has an estimated remaining life of 7 years. The crane can be sold for $14,000. If the crane is kept in service it must be overhauled immediately at a cost of $6,000. Operating and maintenance costs will be $5,000/year after the crane is overhauled. After overhauling it, the crane will have a zero salvage value at the end of the 7-year period. A new crane will cost $36,000, will last for 7 years, and will have a $8000 salvage value at that time. Operating and maintenance costs are $2,500 for the new crane. Esteez uses an interest rate of 15% in evaluating investment alternatives. Should the company buy the new crane based upon an annual cost analysis?
Use the cash flow approach.
Use the cash flow approach.
Explanation / Answer
Solution :
Option 1 : Use the Old crane
Annual equivalent cost of using the old crane = - $6000 (A/P , 15% , 7 years ) - $ 5000
Annual equivalent cost of using the old crane = - $6000 x 0.2403 - $ 5000
Annual equivalent cost of using the old crane = - $ 1,442.30 - $ 5000
Annual equivalent cost of using the old crane = - $ 6442.30
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Option 2 : Buy new crane by selling off old crane for $ 14,000. Thus the new crane costs $ 36,000 - $ 14,000
Cost of new crane will be = $ 22,000
Annual equivalent cost of new crane will be = - $ 22,000 ( (A/P , 15% , 7 years ) + $8000( A/F , 15 % , 7 years ) - $ 2500
Annual equivalent cost of new crane = - $ 22,000 X 0.2403 + $ 8000 X 0.0903 - $ 2500
Annual equivalent cost of new crane = - $ 7064.20
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The company should use the old crane because the annual equivalent cost of new crane is more when compared to old crane .
Use old crane year cash flows 0 ($6,000) 1 ($5,000) 2 ($5,000) 3 ($5,000) 4 ($5,000) 5 ($5,000) 6 ($5,000) 7 ($5,000)