Question: A company is considering replacing an existing machine (defender) with newer machine (challenger). If repaired, the defender can be used for another 5 years. The current market value of the defender is $7, 500 (i.e., it can be sold now for $7, 500). The defender will have a salvage value after 5 years of $250. If kept, the defender will require an immediate $1, 500 overhaul. The operating cost of the defender is $2, 200 during the first year which will increase 40% per year every year after the overhaul. Future market values are expected to decline by 35% per year. The new machine (challenger) has a service life of 7 years. It will cost $10,000 to purchase now. Its annual operation and maintenance cost is $2,000 per year in the first year. This annual operation and maintenance cost will increase by 42% per year for subsequent years. The market value of the challenger will decline by 26% every year over its service life. Use MARR equals 10%.
a. Find the economic lives of:
[i] the defender and
[ii] the challenger.
b. Determine when the defender should be replaced.