# Ass. 3 - Question 1 Replacement Analysis Using Economic...

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Question 1 Replacement Analysis Using Economic Service Life (20 marks) Economic Service Life is the period of useful life that minimizes the annual equivalent costs, in constant dollars, of owning and operating that asset. In Economic Service Life we need to consider explicitly how long an asset should be hold. We learned about Capital costs and operating costs. Capital costs have 2 components, Initial investment (I) (purchase price), and Salvage value (S) The following table summarizes the financial date for a proposed new asset. The issue is how long the asset should be kept. Assume an interest rate (MARR) of 12% and determine the economic service life of the asset before taxes. End of year ( n ) Investment cost O&M cost Salvage value 0 \$10,000 1 \$2,000 \$6,000 2 \$3,000 \$4,500 3 \$4,200 \$3,000 4 \$5,600 \$1,500 5 \$6,500 \$0 Solution: AE n=1 = (10,000 – 6,000)(A/P, 12%, 1) + 0.12(6,000) + 2,000 AE n=1 = \$7,200 (2.5 marks) AE n=2 = (10,000 – 4,500)(A/P, 12%, 2) + 0.12(4,500) + [2,000(P/F, 12%, 1) + 3,000(P/F, 12%, 2)](A/P, 12%, 2) AE n=2 =\$6,266 (2.5 marks) AE n=3 = (10,000 – 3,000)(A/P, 12%, 3) + 0.12(3,000) + [2,000(P/F, 12%, 1) + 3,000(P/F, 12%, 2) + 4,200(P/F, 12%, 3)](A/P, 12%, 3) AE n=3 = \$6,258 (2.5 marks) AE n=4 = (10,000 – 1,500)(A/P, 12%, 4) + 0.12(1,500) + [2,000(P/F, 12%, 1) + 3,000(P/F, 12%, 2) + 4,200(P/F, 12%, 3) + 5,600(P/F, 12%, 4)](A/P, 12%, 4) AE n=4 = \$6,510 (2.5 marks) AE n=5 =(10,000 – 0)(A/P, 12%, 5) + [2,000(P/F, 12%, 1) + 3,000(P/F, 12%, 2) + 4,200(P/F, 12%, 3) + 5,600(P/F, 12%, 4) + 6,500(P/F, 12%, 5)](A/P, 12%, 5) AE n=5 = \$6,773 (2.5 marks) The economic service life is 3 years (2.5 marks)

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Question 2 Replacement Strategies Under the Infinite Planning Horizon (20 marks) Advanced Electrical Insulator Company is considering replacing a broken inspection machine, which has been used to test the mechanical strength of electrical insulators, with a newer and more efficient one. If repaired, the old machine can be used for another five years, although the firm does not expect to realize any salvage value from scrapping it in five years. Alternatively, the firm can sell the machine to another firm in the industry now for \$7,500.
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