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Q3. The management at Big Toy Company is considering purchasing a new machine and it has gathered...

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Finance

Q3.

The management at Big Toy Company is considering purchasing a newmachine and it has gathered the following data:

A) The cash needed to buy the new machine is $65,000
b) The residual value and operating expenses for the next fiveyears are:

YearResidual Value at year endAnnual cash operating expenses
150 00012 000
240 00014 000
330 00018 000
424 00023 000
55 00028 000

C) The required rate of return is 13% per year
D) The effects of company tax can be ignored.

What is the optimum replacement policy for this machine? Showyour workings.

Answer & Explanation Solved by verified expert
3.8 Ratings (440 Votes)

Year Annual operating expenses PVIF for 13% PV of annual operating expenses = Annual operating expenses*PVIF Cumulative PV of operating costs Depreciation = Book value - residual value Total cost = cumulative PV of operating costs+Depreciation Cumulative PV factors Weighted average cost = Total cost/cumulative PV factors
1                                          12,000.00 0.88496                 10,619.47            10,619.47                        15,000.00                     25,619.47 0.88496
2                                          14,000.00 0.78315                 10,964.05            21,583.52                        10,000.00                     31,583.52 1.66810                   18,933.80
3                                          18,000.00 0.69305                 12,474.90            34,058.43                        10,000.00                     44,058.43 2.36115                   18,659.71
4                                          23,000.00 0.61332                 14,106.33            48,164.76                          6,000.00                     54,164.76 2.97447                   18,209.88
5                                          28,000.00 0.54276                 15,197.28            63,362.03                        19,000.00                     82,362.03 3.51723                   23,416.72

Thus the weighted average cost is least in the 4th year and so the machine should be replaced in the 4th year
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Transcribed Image Text

Q3.The management at Big Toy Company is considering purchasing a newmachine and it has gathered the following data:A) The cash needed to buy the new machine is $65,000b) The residual value and operating expenses for the next fiveyears are:YearResidual Value at year endAnnual cash operating expenses150 00012 000240 00014 000330 00018 000424 00023 00055 00028 000C) The required rate of return is 13% per yearD) The effects of company tax can be ignored.What is the optimum replacement policy for this machine? Showyour workings.

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