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 $30,000 annually to operate and still have no salvage value.
What would you pay at the end of year 5 to extend the life of Machine B by two years?
When the depreciation of the machinery, assets or other things is colted then the remaining estimated value is known as the salvage value of that asset, machinery, etc.
Answer and Explanation:
Present worth (PW) of machine A ($) = 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
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
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
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from CFP Certification Exam Study Guide - Certified Financial PlannerChapter 8 / Lesson 1