Philben Pharmaceutics must decide when to replace its autoclave. Philben’s curre
ID: 2802807 • Letter: P
Question
Philben Pharmaceutics must decide when to replace its autoclave. Philben’s current autoclave will require increasing amounts of maintenance each year. The resale value for the equipment falls every year and the equipment has been fully depreciated. The following table presents this data. Year Maintenance Costs Resale Value 0 $0 $900 1 $300 $700 2 $400 $400 3 $500 $200 4 $600 $0 Philben can purchase a new autoclave for $3,000. The new equipment will have an economic life of 6 years. At the end of those years, the equipment will require $50 of maintenance. Philben expects to sell the machine for $1,200 at the end of 6 years. Assume the tax rate is 35%, the straight line depreciation assumed no salvage value, and the opportunity cost of capital for this decision is 10%. When should Philben replace its current machine?
Explanation / Answer
Since NPV is highest if replaced immediately, it is advisable to replace the current machine immediately.
Calculation of Equivalent Annual Cost of new machine: NPV: A Intitial Cash Outflow -3000 B Recurring Costs (Maintenance Costs) 50 Tax Shield on Recurring Costs 17.5 Tax Shield on depreciation ((3000/6)35%) 210 Cash Flow after tax 177.5 PVAF(10%, 6) 4.355261 PV of Recurring Costs 773.0588 C Salvage Value 1200 PVIF(10%,6) 0.564474 PV of Salvage Value 677.3688 D NPV (A+B+C) -1549.57 E EAC (D/PVAF(10%,6)) -355.793 NPV in case of replacement : Costs Tax Cash Flow PVF(10% PV of CF Replaced Immediately: 0 900 315 585 1 585 0 -355.793 -124.528 -231.265 1 -231.265 353.7346 Replaced in one year: 1 -300 -105 -195 0.909091 -177.273 1 700 245 455 0.909091 413.6364 1 -355.793 -124.528 -231.265 0.909091 -210.241 26.12232 Replaced in two years 1 -300 -105 -195 0.909091 -177.273 2 -400 -140 -260 0.826446 -214.876 2 400 140 260 0.826446 214.876 2 -355.793 -124.528 -231.265 0.826446 -191.128 -368.401 Replace in three years 1 -300 -105 -195 0.909091 -177.273 2 -400 -140 -260 0.826446 -214.876 3 -500 -175 -325 0.751315 -244.177 3 200 70 130 0.751315 97.67092 3 -355.793 -124.528 -231.265 0.751315 -173.753 -712.408 Replace in four years 1 -300 -105 -195 0.909091 -177.273 2 -400 -140 -260 0.826446 -214.876 3 -500 -175 -325 0.751315 -244.177 4 -600 -210 -390 0.683013 -266.375 4 -355.793 -124.528 -231.265 0.683013 -157.957 -1060.66