Q3. The management at Big Toy Company is considering purchasing a new machine and it has gathered...

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Finance

Q3.

The management at Big Toy Company is considering purchasing a newmachine and it has gathered the following data:
A) The cash needed to buy the new machine is $65,000
b) The residual value and operating expenses for the next fiveyears are:
Year Residual Value at year end Annual cash operating expenses
1 50 000 12 000
2 40 000 14 000
3 30 000 18 000
4 24 000 23 000
5 5 000 28 000
C) The required rate of return is 13% per year
D) The effects of company tax can be ignored.
What is the optimum replacement policy for this machine? Showyour workings.

Answer & Explanation Solved by verified expert

3.8 Ratings (440 Votes)

Year	Annual operating expenses	PVIF for 13%	PV of annual operating expenses = Annual operating expenses*PVIF	Cumulative PV of operating costs	Depreciation = Book value - residual value	Total cost = cumulative PV of operating costs+Depreciation	Cumulative PV factors	Weighted average cost = Total cost/cumulative PV factors
1	12,000.00	0.88496	10,619.47	10,619.47	15,000.00	25,619.47	0.88496
2	14,000.00	0.78315	10,964.05	21,583.52	10,000.00	31,583.52	1.66810	18,933.80
3	18,000.00	0.69305	12,474.90	34,058.43	10,000.00	44,058.43	2.36115	18,659.71
4	23,000.00	0.61332	14,106.33	48,164.76	6,000.00	54,164.76	2.97447	18,209.88
5	28,000.00	0.54276	15,197.28	63,362.03	19,000.00	82,362.03	3.51723	23,416.72

Thus the weighted average cost is least in the 4th year and so the machine should be replaced in the 4th year

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Transcribed Image Text

Q3.The management at Big Toy Company is considering purchasing a newmachine and it has gathered the following data:A) The cash needed to buy the new machine is $65,000b) The residual value and operating expenses for the next fiveyears are:YearResidual Value at year endAnnual cash operating expenses150 00012 000240 00014 000330 00018 000424 00023 00055 00028 000C) The required rate of return is 13% per yearD) The effects of company tax can be ignored.What is the optimum replacement policy for this machine? Showyour workings.

Year	Residual Value at year end	Annual cash operating expenses
1	50 000	12 000
2	40 000	14 000
3	30 000	18 000
4	24 000	23 000
5	5 000	28 000