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Ballou 12
Ballou 12
+
+
+ =
where
NPV = net present value of equipment over its useful life
($)
I = initial investment ($)
C = annual operating cost ($)
i = the discount, or hurdle, rate that such investments
are expected to return
S
n
= salvage value in year n ($)
n = useful life of the equipment (years)
CR (2004) Prentice Hall, Inc.
12-23
Equipment Selection (Contd)
Problem Two type A forklift trucks can do the same
work as three type B trucks. Additional data are:
Two Type A
Trucks
Three Type B
Trucks
Total initial investment $20,000 $15,000
Useful life (planned) 7 7
Salvage value
(estimated)
$ 5,000 $ 2,000
Annual operating
expenses
$ 4,000 $ 6,000
Hurdle rate 0.20 0.20
CR (2004) Prentice Hall, Inc.
12-24
Equipment Selection (Contd)
Solution
Solve the NPV equation for the two alternatives.
For truck type A,
000 , 33 $
) 2 . 0 1 (
000 , 5
) 2 . 0 1 ( 2 . 0
1 ) 2 . 0 1 (
000 , 4 000 , 20
7 7
7
=
+
+
+
+ =
A
NPV
For truck type B,
040 , 36 $
) 2 . 0 1 (
000 , 2
) 2 . 0 1 ( 2 . 0
1 ) 2 . 0 1 (
000 , 6 000 , 15
7 7
7
=
+
+
+
+ =
B
NPV
Choose two type A trucks
CR (2004) Prentice Hall, Inc.
12-25
Equipment Replacement
-A financial problem
-Alternatives are compared through present value
analysis
-Typical design concerns differing degrees of
automation, capacity, and equipment life.
Example A forklift truck that costs $3,000 and requires $200
to operate in its first year, but operating costs increase at the
rate of $30 per year squared thereafter. Technological
improvement reduces operating costs by $20 per year. The
normal life of a truck is 10 years and the truck can be sold for
its remaining undepreciated value. A discount rate of 20%/yr.
is used. When should the truck be replaced?
We calculate the equivalent annual cost according to
(
+
+
(
+
+ =
=
1 ) 1 (
) 1 (
) 1 ( ) 1 (
1
n
n n
j
n
n
j
j
n
i
i i
i
S
i
C
I AC
Accumulates costs
for years 1 and 2
Replacement Example
a
Computed as C
j
=200 - 20(j-1) + 30(j-1)
2
and accumulated when there is more
than one year in the replacement cycle
b
Computed as S
n
= I[1-0.1(n)]
Replace-
ment
Cycle
Time, n
(1)
Initial
Invest-
ment, I
(2)
Total
Operating
Costs, C
j
(3)
Discounted
Operating
Costs,
C
i
j
j
j
n
( ) 1
1
+
=
(4)
Salvage
Value,
S
n
(5)
Discounted
Salvage
Value,
S
i
n
n
( ) 1
+
(6)
Discount
Factor,
i i
i
n
n
( )
( )
1
1 1
+
+
(7)=
(1+3-5)(6)
Equivalent
Average
Annual
Cost,
AC
n
1 $3,000 $200
a
$167 $2,700
b
$2,250 1.20 $1,100
2 3,000 410 312 2,400 1,668 0.65 1,068
3 3,000 690 475 2,100 1,215 0.47 1,062
4 3,000 1,100 672 1,800 868 0.39 1,094
5 3,000 1,700 913 1,500 603 0.33 1,092
6 3,000 2,550 1,198 1,200 402 0.30 1,138
7 3,000 3,710 1,522 900 251 0.28 1,196
8 3,000 5,240 1,878 600 140 0.26 1,232
9 3,000 7,200 2,258 300 58 0.25 1,300
10 3,000 9,650 2,653 0 0 0.24 1,357
CR (2004) Prentice Hall, Inc.
12-26