Problem: Gillian is deciding whether to replace an old machine, and has assembled some information. She believes that the second-hand market value of either machine will decline over time in line with the depreciation schedule (eg. the old machine should sell for $3,000 today). If there are no taxes, and Gillian's required rate of return is 15% p.a.:
1) What is the optimal replacement cycle for the new machine?
2) Should the old machine be replaced now or next year?
| |
Old Machine |
New Machine |
| Life at purchase |
3 years |
3 years |
| Remaining life |
1 year |
3 years |
| Cost at purchase |
$9,000 |
$12,000 |
| Depreciation (p.a.) |
$3,000 |
$4,000 |
| Revenue (p.a.) |
$6,000 |
$7,000 |
| Expenses - Year 1 |
$2,000 |
$1,000 |
| - Year 2 |
|
$1,500 |
| - Year 3 |
|
$2,250 |
| Salvage Value |
Book Value |
Book Value |