Question - Asset Replacement
Missouri River Energy Company provides electrical services to several rural counties in Nebraska and South Dakota. Its efficiency has been greatly affected by changes in technology. The company is currently considering the replacement of its main steam turbine, which was put in place in the 1980s but is now technologically obsolete. The turbine's operation is very reliable, but it is much less efficient than newer, computer-controlled turbines. The controller presented the following financial information to corporate management:
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Old Turbine
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New Turbine
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Original cost
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$4,000,000
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$6,000,000
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Market value now
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$400,000
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$6,000,000
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Remaining life
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8 years
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8 years
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Quarterly operating costs
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$210,000
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$45,000
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Salvage value in eight years
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$0
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$0
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Accumulated depreciation
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$800,000
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N/A
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a. Identify the costs that are relevant to the company's equipment replacement decision.
b. Determine whether it is more financially sound to keep the old turbine or replace it. Provide your own computations based on relevant costs only.
c. For this part only, assume that the acquisition cost of the new technology is unknown. What is the maximum amount that the company could pay for the new technology and be in the same financial condition as it is in currently?
d. What other considerations would come into play if, rather than a new turbine, the company were considering solar-powered technology to replace the old turbine system?