H7 - current equipment in fifteen months if they still want...

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H AAS S CHOOL OF B USINESS U NIVERSITY OF C ALIFORNIA AT B ERKELEY UGBA 103 A VINASH V ERMA H OMEWORK 7 Due July 25, 2011 1. ABC Fitness Club has exercise equipment that costs $18,000. They replace it every five years with an identical unit [the same make and model], and sell the old unit for $1,800. The technology and the prices are expected to remain unchanged in perpetuity, and, therefore, taking ABC Fitness Club to be a going concern, they can be reasonably expected to follow this replacement policy for ever. In July 2008, exactly three years ago, they bought the current equipment. Therefore, given the replacement policy and normal use, it will be replaced in exactly two years from now. XYZ Health Club, a sister facility in the neighborhood, closed down temporarily, and asked ABC Fitness Club to let its members use ABC’s facilities until it reopens. Taking into account the membership of the two clubs, it is estimated that ABC Club will have to replace their
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Unformatted text preview: current equipment in fifteen months if they still want to sell the old unit for $1,800. In other words, the life of the current unit will be shortened by nine months on account of its use by members of XYZ Health Club. Assuming the discount rate to be 0.36% per month, what payment from XYZ Health Club would compensate ABC Fitness Club for the fact that their current equipment will need replacement 9 months earlier than would have been necessary at the rate of normal use? 2. Suppose a firm with a cost of capital of 15% per year needs equipment on an ongoing basis. The equipment costs $120K to buy at t=0, and the operating and maintenance (O&M) costs at t=1,2,…9 are $15K, $15K, $20K, $20K, $30K, $40K, $50K, $60K, and $80K respectively. Work out how often the firm should replace one unit with another in order to minimize the total costs (sum of replacement and O&M costs)....
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