A small company that manufactures vibration isolation platforms is trying to dec
ID: 2646068 • Letter: A
Question
A small company that manufactures vibration isolation platforms is trying to decide whether it should upgrade the current assembly system (System D), which is rather labor-intensive, with one that is more highly automated (System C). Some components of the current system can be sold now for $9000, but they will be worthless hereafter. The operating cost of the existing system is $192,000 per year. System C will cost $320,000 with a $50,000 salvage value after four years. Its operating cost will be $68,000 per year. If you are told to do a replacement analysis over a 2-year planning period using an interest rate of 10% per year, which system do you recommend? Assume the salvage value of system C after two years is estimated at $100,000.
System D System C
Market value, $ 9,000 320,000
Annual cost, $/year -192,000 -68,000
Salvage value, $ 0 50,000
Life, years 2 4
Explanation / Answer
IF we continue Current system System D Cash flows Present value of Annual cost = (192000 * 1.7355) $ 333,216.00 PVF at 10% for 2 years = 1.7355 Present value of cash outflows $ 333,216.00 IF we accept new system System C Initial cost 320000 Present value of Annual cost = (68000 * 1.7355) 118014 PVF at 10% for 2 years = 1.7355 Present value Salvage value recived at the end of year 2 -82640 (100000*0.8264) Present value of cash outflows $ 355,374.00 we can see the PV of cash outflow is less in case we continue System D Hence it is advisable to continue old system D