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Unformatted text preview: Topic 5 Special Issues in Capital Budgeting Readings: • Chap 7 (7.5) & Chap 8 (8.38.4) 11.45 Equivalent Annual Cost Two machines generate the same amount of revenue each year. Costs and life spans are different for the two machines. Costs each year are in the table below. If you want to choose one machine and replace it with the same machine forever, which one should you choose? The discount rate is 6%. Year Mach .0 1 2 3 PV @6% EAC A 15 4 4 4 B 10 6 6 25.69 21.00 9.61 Replacement Decisions Your existing old machine will last 2 more years before it breaks down. It costs $12,000 per year to operate. However, you can replace it now with a new machine at a cost of $18,000 to buy and an additional $8,000 per year to operate. The new machine lasts for 5 years. You expect to keep replacing the machine forever. Should you replace the old machine now or wait until the old machine breaks down? Assuming that both machines have the same output and your discount rate is 6%. What if you could resell the new machine for $6,000 aftertax at the end of 5 years? Investment Timing Sometimes the question is not whether to undertake a project, but when. Buying a new computer system will improve efficiency and save money. Let’s say the new computer system costs $50,000 today and can save $70,000. For simplicity, let’s assume that $70,000 savings happen immediately. The discount rate is 15%. Should you buy the new computer system? Investment Timing Wait, things are a little more complicated than that. Let’s say the price of the computer system decreases by $5,000 every year. Assuming the discount rate is 15%....
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 Spring '11
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 Finance

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