Problem:
The Burnaby Machine Company makes small parts under contract for manufacturers in the Vancouver area. The company makes a group of metal parts on a turret lathe for a local ski manufacturer. The current lathe is now six years old. It has a planned further life of three years. The contract with the ski manufacturer has three more years to run as well. A new, improved lathe has become available. The challenger will have lower operating costs than the defender.
The defender can now be sold for $1200 in the used-equipment market. The challenger will cost $25,000 including installation. Its salvage value after installation, but before use, will be $20,000. Further data for the defender and the challenger are shown in the tables.
Defender
Additional Salvage Value Operating Cost
Life on Years
0 $1200
1 600 $20,000
2 300 20,500
3 150 21,012.50
Challenger
Life in years Salvage year Operating Cost
0 20000
1 14000 13875
2 9800 14360.63
3 6860 14863.25
Burnaby machine is not sure if the contract it has with the ski company will be renewed. Therefore, Burnaby wants to make the decision about replacing the defender with the challenger using a three-year study period. Burnaby Machine uses a 12% MARR for this type of investment.
Q1. What is the present worth of costs over the next three years for the defender?
Q2. What is the present worth of costs over the next three years for the challenger?
Q3. Now suppose that Burnaby did not have a good estimate of the salvage of the challenger at the end of three years. What minimum salvage value for the challenger at the end of three years would make the present worth of costs for the challenger equal to that of the defender?