ACCA FM · Guided practice (Show me how)
Chapter 9: Discounted cash flow – further aspects
Asset replacement - equivalent annual cost
A machine costs $72,000 and has a maximum life of 3 years. Its running costs and estimated scrap values are:
| Year | Running cost $ | Scrap value at the end of the year $ |
|---|---|---|
| 1 | 7,200 | 24,000 |
| 2 | 9,600 | 16,600 |
| 3 | 12,000 | 9,600 |
The cost of capital is 15%. How often should the machine be replaced? Sign convention: present values of net costs are entered as negative figures; equivalent annual costs as positive costs per year.
(a) The one-year and two-year cycles
Calculate the machine's present value of net costs and equivalent annual cost for the specified shorter replacement cycles.
(b) The three-year cycle and the decision
Calculate the machine's present value of net costs and equivalent annual cost for the longest replacement cycle, and identify the preferred replacement policy.
Opening this exercise…