# Your company needs a machine for the next seven years, and you have two choices (assume an annual...

## Question:

Your company needs a machine for the next seven years, and you have two choices (assume an annual interest rate of 15%).

Machine A costs $100,000 and has an annual operating cost of $47,000. Machine A has a useful life of 7 years and a salvage value of $15,000. Machine B costs $150,000 and has an annual operating cost of $30,000.

Machine B has a useful life of 5 years and no salvage value. However, the life of Machine B can be exteded by two years with a certain amount of investment. if Machine B's life is extended, it will still cost $30,000 annually to operate and still have no salvage value.

What would you pay at the end of year 5 to extend the life of Machine B by two years?

## Salvage Value:

When the depreciation of the machinery, assets or other things is colted then the remaining estimated value is known as the salvage value of that asset, machinery, etc.

## Answer and Explanation:

Present worth (PW) of machine A ($) = 100,000 + 47,000 x PVIFA (15%, 7 years) - 15,000 x PVIF (15%, 7 years)

= 100,000 + 47,000 x 4.1604 - 15,000 x 0.3759

= 100,000 + 195,539 - 5,639

= 289,900

PW of machine B ($) without considering the additional investment = 150,000 + 30,000 x PVIFA (15%, 7 years)

= 150,000 + 30,00 x 4.1604

= 150,000 + 124,812

= 274,812

Therefore, the difference in the PW of two machines is the present value of additional investment for B at the end of 5 years, equal to

P = $(289,900 - 274,812) = $15,088

Value of this amount at end of 5 years (when this investment is required) = $15,088 x (1.15)5

= $15,088 x 2.0114

= $30,347

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from CFP Certification Exam Study Guide - Certified Financial Planner

Chapter 8 / Lesson 1