SRI KRISHNA ARTS AND SCIENCE COLLEGE

COIMBATORE

Programme : Commerce Streams

Course : Business Mathematics

Unit – IV : Replacement Models

SKASC 1
 Replacement Models- Money Value, Pwf, Discount
Rate
 Problem
1. The cost of a new machine is Rs.5000. The maintenance cost of
nth year is given by Cn=500(n-1);n=1,2,.... Suppose that money is
worth 5% per year, after how many years will it be economical to
replace the machine by a new one?

Solution:

The present worth of the money to be spent a year from now is

V=1/(1+0.05)=0.9523
Since W(n) is minimum for n=5 and R4 =1500 <w(5) as well as
w(5)>R6=2500,it is economical to replace the machine by a new one at
the end of 5 years.
 Problem
2. A production machine installed has initial investment of Rs.30,000 and
its salvage value at the end of i years of its use is estimated as
Rs.(30,000/(i+1)) . The annual operating and maintenance cost in the
first year is Rs.15,000 and increases by Rs.1000 in each subsequent
years for first five years and increases by Rs.5000 in each year
thereafter. Replacement policy is to be planned over a period of seven
years. During this period cost of capital may be taken as 10% per year.
Solve the problem for optimal replacement.
Solution :

Here C=30,000 V=1/1.10

Problem
3. A person is considering to purchase a machine for his own factory.
Relevant data about alternative machines are as follows

Machine A Machine B Machine C

Present Investment 10000 12000 15000
(Rs)
Total annual 2000 1500 1200
cost(Rs)
Life (years) 10 10 10
Salvage value 500 1000 1200
As an adviser to the buyer, you have been asked to select the best
machine, considering 12 % normal rate of return. You are given that (i)
single payment present worth factor (pwf) at 12% for 10 years=0.322

(ii)Annual series present worth factor (pwf) at 12% for 10 years=5.650

Solution : The present value of total cost of each of the three machines
for a period of 10 years is given below :

Machine Present P.Value of total Present Value of Net cost (Rs)

Investment Annual cost Salvage Value (1)+(2)-(3)
(1) (2) (3) (4)
A 10000 2000*5.65=11300 500*0.322=161 21139
B 12000 1500*5.65=8475 1000*0.322=322 20,153
C 15000 1200*5.65=6780 1200*0.322=386.4 21393.6

From the above data we conclude that the present value of total cost for
machine B is the least and hence machine B should be purchased.
Problem
4. A manufacture is offered two machines A and B. A is priced at Rs. 5000
and running costs are estimated at Rs. 800 for each of the first five years,
increasing by Rs.200 per year in the sixth and subsequent years. Machine
B, which has the same capacity as A, costs Rs. 2500 but will have running
costs of Rs.1200 per year for six years, increasing by Rs. 200 per year
thereafter. If money is worth 10% per year which machine should be
purchased ? Assume that the machines will eventually be sold for scrap at
a negligible price.
Solution :

Since the discount rate of money per year is given as 10% the present
worth of the money to be spent over a period of one year is
V=(1 + 0.10)−1 = 0.9091.

We calculate the following tables for machine A and machine B

Year n 𝑹𝒏 𝑽𝒏−𝟏 𝑹𝒏 𝑽𝒏−𝟏 C+ W(n)=(5)/
𝑽𝒏−𝟏
(1) (2) (3) (4) 𝑹𝒏 𝑽𝒏−𝟏 (6)
(5) (6)
1 800 1.000 800 5800 1.000 5800
2 800 0.9091 727 6527 1.9091 3418
3 800 0.8264 661 7188 2.7355 2627
4 800 0.7513 601 7789 3.4868 2233
5 800 0.6830 546 8335 4.1698 1998
6 1000 0.6290 621 8956 4.7907 1896
7 1200 0.5645 677 9633 5.3552 1798
8 1400 0.5132 718 10351 5.8684 1763
9 1600 0.4665 746 11097 6.3349 1751
10 1800 0.4241 763 11860 6.7590 1754
Year n 𝑹𝒏 𝑽𝒏−𝟏 𝑹𝒏 𝑽𝒏−𝟏 C+ W(n)=(5)/
𝑽𝒏−𝟏
(1) (2) (3) (4) 𝑹𝒏 𝑽𝒏−𝟏 (6)
(5) (6)
1 1200 1.000 1200 3700 1.000 3700
2 1200 0.909 1091 4791 1.909 2509
3 1200 0.826 991 5782 2.735 2114
4 1200 0.751 901 6683 3.486 1917
5 1200 0.683 820 7503 4.169 1799
6 1200 0.621 745 8248 4.790 1722
7 1400 0.564 789 9037 5.355 1687
8 1600 0.513 821 9858 5.868 1679
9 1800 0.466 839 10697 6.334 1688
10 2000 0.424 848 11545 6.759 1709
From the above tables we observe for machine A 𝑅10 > 𝑤(9) and for
machine B 𝑅10 > 𝑤(8) .

=> Machine A is replaced at the end of 9th year and machine B is replaced
at the end of 8th year. Machine B is preferred.
Practice Problems
1. A machine cost Rs.10,000 operating costs are Rs.500 per year
for the first five years. In the sixth and succeeding years operating
cost increased by Rs.100 per year. Assuming a 10% discount rate
of money per year, find the optimum length of time to hold the
machine before we replace it.
 Practice Problems
2. A lorry owner estimates that the running costs and salvage values
of truck for various years will be as given below:

Year Running Cost Salvage Cost

1 6000 60000
2 7500 40000
3 9000 30000
4 12000 25000
5 15000 20000
6 20000 2000
7 20000 2000
8 30000 2000
If the purchase price is Rs.80,000, estimate the optimum replacement
age, assuming that the rate of return on capital investment is Rs.15%
per year