Prof. Rajeev Nair 1 IET 310: 301 Engineering Economic Analysis: Fall 2011
Homework # 10 (Based on Chapter 13) (50 points)
Due date - December 7’Th (Wednesday), 2011, before 11.55 PM EST
Prof. Rajeev Nair
1. A drill press was purchased 2 years ago for $40,000. The press can be sold for $15,000 today, or
for $12,000, $10,000, $8,000, $6,000, $4,000, or $2,000 at the ends of each of the next 6 years. The
annual operating and maintenance cost for the next 6 years will be $2,700, $2,900, $3,300, $3,700,
$4,200 and $4,700. Determine the marginal cost to extend service for each of the next 6 years if the
MARR is 12%. If a new drill press has an EAC of $7,000, when should the drill press be replaced
(10 points)?
Year
0
1
2
3
4
5
6
Market Value
$15,000
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
Loss in Market
Value in Year n
$3,000
$2,000
$2,000
$2,000
$2,000
$2,000
Interest
in Year
n
Operating
Cost in
Year n
Marginal
Cost in
Year n
$1,440
$1,200
$960
$720
$480
$240
$2,700
$2,900
$3,300
$3,700
$4,200
$4,700
$7,140
$6,100
$6,260
$6,420
$6,680
$6,940
Although the marginal cost is above the $7000 mark in the first year, it decreases in subsequent
years, therefore I would recommend not replacing the unit until the end of the 6th year.
2. A five year-old defender has a current market value of $4,000 and expected O & M costs of
$3,000 this year, and increasing by $1,500 per year. Future market values are expected to decline by
$1,000 per year. The machine can be used for another three years. The challenger costs $6,000 and
has O & M costs of $2,000 per year, increasing by $1,000 per year. The machine will be needed for
only three years, and the salvage value at the end of that time is expected to be $2,000. The MARR is
15%. (10 points).
(a) Determine the annual cash flows for retaining the old machine for three years.
Defender
Current Market
Year
Value
O&M Cost
cash flow
IRR
0
$4,000
$3,000
$1,000
1
$3,000
$4,500
$1,500
2
$2,000
$6,000
$4,000
3
$1,000
$7,500
$6,500
-230.52%
(b) Determine whether the time to replace the old machine is now. First show the annual cash
flows for the challenger.
Challenger
Salvage
Year
Cost
O&M Cost
Value
Cash Flow
0
$6,000
$6,000
1
$2,000
$4,667
$4,000
2
$3,000
$3,333
$1,667
3
$4,000
$2,000
$667
IRR= 103.19%
I would replace the old machine now.
3. Mary O’Leary’s company, ships fine wool garments from County Cork, Ireland. Five years ago
she purchased some new automated packing equipment having a first cost of $125,000 and a
MACRS class life of 7 years. The annual costs for operating, maintenance, and insurance, as well as
market value data for each year of the equipment’s 10-year useful life are as follows (10 points).
Year n
Operating ($)
1
2
3
4
5
6
7
8
9
10
16,000
20,000
24,000
28,000
32,000
36,000
40,000
44,000
48,000
52,000
Annual costs in Year n Market Value
for,
in Year n
Maintenance ($)
Insurance ($)
5,000
17,000
80,000
10,000
16,000
78,000
15,000
15,000
76,000
20,000
14,000
74,000
25,000
12,000
72,000
30,000
11,000
70,000
35,000
10,000
68,000
40,000
10,000
66,000
45,000
10,000
64,000
50,000
10,000
62,000
Now Mary is looking at the remaining 5 years of her investment in this equipment, which she had
initially evaluated on the basis of an after-tax MARR of 25% and a tax rate of 35%. Assume that the
replacement repeatability assumptions are valid.
(a) What is the before-tax marginal cost for the remaining 5 years?
(b) When, if at all, should Mary replace this packing equipment if a new challenger, with a minimum
EUAC of $110,000, has been identified?
4. Five years ago, a conveyor system was installed in a manufacturing plant at a cost of $35,000. It
was estimated that the system, which is still in operating condition, would have a useful life of eight
years with a salvage value of $3,000. It was also estimated that if the firm continues to operate the
system, its market values and operating costs for the next three years would be as follows (10 points).
Year End
0
1
2
3
Market Value
($)
11,500
5,200
3,500
1,200
Book Value
($)
15,000
11,000
7,000
3,000
Operating Cost
($)
4,500
5,300
6,100
A new system can be installed for $43,500; it would have an estimated economic value of 10 years
with a salvage value of $3,500. Operating costs are expected to be $1,500 per year throughout the
service life of the system. The firm’s MARR is 18%. The system belongs to the seven-year MACRS
property class. The firm’s marginal tax rate is 35%.
(a) Decide whether to replace the existing system now.
(b) If the decision is to replace the existing system, when should replacement occur?
5. A professor of engineering economics owns a 1996 car. In the past 12 months, he has paid $2,000
to replace the transmission, bought two new tires for $160, and installed a CD player for $110. He
wants to keep the car for 2 more years because he invested money three years ago in a five-year
certificate of deposit, which is earmarked to pay for his dream machine, a red European sports car.
Today the old car’s engine failed. The professor has two alternatives. He can have the engine
overhauled at a cost of $1,800 and then most likely have to pay another $800 per year for the next
two years for maintenance. The car will have no salvage value at that time. Alternatively, a colleague
offered to make the professor a $5,000 loan to buy another used car. He must pay the loan back in
two equal installments of $2,500 due at the end of Year 1 and Year 2, and at the second year he must
give the colleague the car. The “new” used car has an expected annual maintenance cost of $300. If
the professor selects this alternative, he can sell his current vehicle to a junkyard for $1,500. Interest
is 5%. Using present worth analysis, which alternative should he select and why (10 points)?
Defender
year
0
1
2
Challenger
year
0
1
2
paid out
$2,270
$1,800
maint
$800
$800
paid out
maint/payback
$5,000
$2,800
$2,800
total pay
out
$3,070
$2,600
$5,670
Salvage
total
$1,500
$4,100 plus car
I would advise that he repair the old car with the possibility of it lasting longer than the expected two
years. Simply because at the end of the two years if he borrows the money from his colleague, he will
end up paying $4100 and no car, unless he can afford his dream car by that time.
Note – Units are important. If units are not present, 10% per problem will be deducted.