A new heat treatment furnace to be used by an aluminum fabrication plant in Southern Ontario costs $30,000 to buy. The new furnace will also cost the plant $1, 200 immediately in installation and training expenses. Operating and maintenance costs are estimated at $3,000 for the first year, and to increase by $1, 320 per year thereafter. The scrap value of the furnace can be estimated at any time by a declining-balance rate of 15% and the interest rate is 10%.
a) Determine the EAC (Equivalent Annual Cost) for the furnace over one year, two years, three years and four years of service life.
b) How often should the furnace be replaced, assuming cash flows and interest rates are to be constant over the plant time horizon?
c) What depreciation rate will lead to $3,000 book value for the furnace after four years of use?
d) What does the term "sunk cost" refer to and how would it affect a replacement decision?