You work as an equipment manager and is considering how often the equipment should be replaced. Suppose a new machine has the following costs over its useful life:
PERIOD Cost comment
(In thousand)
0 $20 purchasing price
1 $1 maintenance cost
2 $1.5 maintenance cost
3 $2.5 maintenance cost
4 $4 maintenance cost
5 $6 maintenance cost
6 $8.5 maintenance cost
7 $12 maintenance cost
The cost of capital is 10%.
a. Determine the optimal time for the machine to be replaced. (Assume that the same machine can be purchased at the same price, ignoring inflation)
b. If you had to buy the machine and rent to the production manager for that machine’s economic life, what annual rental payment would you have to charge?