Chapter 7

Problem no.7.1
a) What are the main causes for replacement of the assets?
b) What do you understand by the term "sunk cost" how do you deal with
this cost?
c) A special drilling machine is being installed at a first cost of $18000
and it has an average annual operating cost of $4200. Maintenance cost is
estimated to be $3300 for the first year and rises at a constant rate of $600
per year thereafter. If the salvage value is $3600 at any time, sketch cash
flow diagrams and determine the economic life of the machine and its
minimum equivalent annual cost in the following cases:
i) When interest is neglected.
ii) When the minimum attractive rate of return, MMR, is 12%.

Solution:
a) There are three main reasons for replacement:
i) Accidents: an asset may lose its capability and value due
to an accident or casualty such as fire, explosion
mechanical damage.
ii) Physical impairment: it is the total or partial loss of
capacity of an asset through usage and/or time.
iii) Functional deterioration: an asset is said to be functional
deteriorated when it becomes obsolete.
b) Sunk cost is a past cost or past losses that can not be altered by
future action. Some times it is defined as a past expense that should
not affect the future feasibility or venture.
Sunk cost should be ignored.
 c) Cash flow diagrams are shown below:

Maintenance and operation

0 1 2 3 4 n

3300 3900
4200 4200 4200 4200
4500 4200
5100
Ao+ (n-1)G

CRWR

SV=$3600

1 2 n

P= $18000

i) Neglecting the interest rate:

CRWR = 18000/n – 3600/n = 14400/n
M&O = Ao+ [G(1+2+….+(n-1))]/n + 4200
TEA = 14400/n + 3300 + [600(1+2+…+(n-1))]/n + 4200
TEA = 7500 + [14400 + 600(1+2+…+(n-1))]/n

N TEA
1 21900
2 15000
3 12900
4 12000
5 11580
6 11400
7 11357.14
8 11400
9 11500
10 11640

From the table above economic life of the machine is 7 years, and the
minimum equivalent annual cost is $11357.14.
ii) TEA = CRWR + M&O
CRWR = (P - SV) (A/P i,n) + SV(i)
M&O = 4200 + 3300 + 600 (A/G i,n)
TEA = 14400 (A/P 12,n) + 3600 * 0.12 + 4200 + 3300 + 600 (A/G 12,n)
TEA = 7932 + 14400 (A/P 12,n) + 600 (A/G 12,n)

n (A/P 12,n) (A/G 12,n) TEA

1 1.12 0.0000 24060

2 0.5917 0.4717 16735.5

3 0.41635 0.92461 14482.2

4 0.32923 1.35885 13484.4

5 0.27741 1.77640 12498.84

6 0.2432 2.172 12737.28

7 0.21912 2.55147 12618.21

From the table above the economic life of the machine equals five years,
and the minimum equivalent annual cost is $12498.84.

Problem No.7.2
An asset, with first cost of 45,000$ and an estimated salvage value of
5,000$ at the end of a physical life of 7 years, depreciates according
to SYD model. The maintenance and operating cost ,M&O, for any
year "t" is assumed to be located at the end of that year and it is given
: by the following expression

1.05
M&O =2,500 (t-1)
Money can be invested at a nominal rate of 20% compounded
.annually
a) Determine and tabulate values for M&O cost and B t for
t=1,2,3,......,7 years.
b) Determine the total annual cost ,TEA, for the asset when it is used
for the following periods:
One year *
Three years *
Five years *
?c) What is the economic life of the asset

B t = F+(P-F)(n-t / n)(n-t+1 / n+1)

B t =5000+(4000) (7-t)(8-t) / 56
TEA= CRWR+M&O
  A/ P 20 , n

CRWR=(P-SV)   +SV(i)

t
EA(t)=(P-B ) T
+0.2B t +2  A/ P 20,t

t tB CRWR M&O TEA



 1 35000 19000 0 19000
1.05
0(t-1) 2 26429 17442.38 2500 19942.38 50
3 19286 16063.64 5176.33 21239.97
4 13571 14855.22 7923.50 22778.72
5 9286 13799.96 10717.73 24517.69
6 6429 12884.10 13547.73 26431.58
7 5000 12096.00 16405.85 28501.85

b) TEA(1) =CRWR(1) +M&O(1) =19000+0.0=19000$

TEA(3)=21,239.97$
TEA(5)=24,517.69$

.C)The economic life of the asset is one year

Problem no.7.2
An asset, with first cost of $45,000 and an estimated saving value of
$5,000 at the end of a physical life of 7 years, depreciates according to
SYD model. The maintenance and operating cost, M&O, for any year "t"
is assumed to be located at the end of that year and it is given by the
:following expression

M&O= $ 2,500(t-1)1.05

.Money can be invested at a nominal rate of 20% compounded annually

A) Determine and tabulate values for M&O cost and Bt for t=1, 2, 3 …7
years

B) Determine the total annual cost, TEA, for the asset when it is used for
:the following periods

One year *

* Three years, and

*Five years

?C) What is the economic life of the asset

SOLUTION
(A

The book depreciation value (SYD model) of the asset has the following
:diagram
:First we draw the cash flow diagram which is shown below
 SV=$5000
7 6 5 4 3 2 1 0

2500

P=$45000 m=20%

The general solution will be

Bt=F+ (P-F) [(n-t)/n] [(n-t+1)/ (n+1)]

And numerical solution then will be $5000+ (40000)*([(7-t)*(8-t)]/56)

A/P 20, n
Also TEA= CRWR+M&O= (P-SV) ( ) + SV (i) +M&O

A/P 20, t A/P 20, t t

( )*0.2Bt + ( ) ∑ [M&O(t)/(1.2)t] TEA= (P-SV)+
t=1

t Bt CRWR 1st
component M&O=2500*(t- TEA M&O=2500(t- TEA
of TEA 1)1.05 1)0.95
1 $35000 19000.00$ 0.0 $19000.00 0.0 $19000.00
2 $26429 17442.38 $ 2500 $18578.84 2500 $18578.84
3 19286$ $16063.64 5176.33 $18309.76 4829.68 $18214.54
4 $13571 $14855.22 7923.50 18159.17$ 7099.13 17928.10
5 $9286 $13799.96 10717.73 $18100.35 9330.33 17713.88$
6 6429 $ $12884.10 13547.48 18115.39$ 11533.5 $17565.05
7 $5000 $12096.00 16405.85 $18192.04 13714.63 $17475.99
(B
A/P 20, 1
TEA (1) = (45000-35000) (1.200 ) + (35000) (0.2) +0.0= $ 19000

A/P 20, 3
TEA(3)=(450000-19286) ( 0.4747 ) +(19286)(0.2)+[2500/
(1.2)2+5176.33/(1.2)3]
A/P 20,3
18309.76 $=( 0.4747 )

A/P 20,5
TEA(5)=(450000-9286) ( 0.3344 ) +(9286)(0.2)+[2500/
(1.2)2+5176.33/(1.2)3+7923.50/(1.2)4+10717.73/(1.2)5]
A/P 20,5
18100.35 $=( 0.3344 )

(C
TO find the economic life of the asset we use the above table to find
.the number of years that results in the minimum total annual cost
For
M&O=2500*(t-1)1.05
N=5 years
For
M&O=2500*(t-1)0.95
N= 7years

:Problem (7.3)

A manufacturer of cans and packaging for the food industry is

considering the replacement of some of its current production equipment.
The equipment presently in operation was installed 3 years ago at a cost
of $90,000 with estimated total service life of 10 years and can presently
be sold for $60,000. The salvage value of the present equipment after one
year is estimated to be $55,000 and is expected to decline uniformly by
$5,000. If the present equipment is retained one more year, its operating
and maintenance costs are expected to be $10,000 with uniform annual
increase of “x” dollars every year thereafter, where the numerical values
 of “x” are given below. The new equipment will cost $80,000. Its
economic life is predicted to be 7 years with a salvage value of $20,000.
Annual operating and maintenance costs for new equipment will remain
constant at $6575. If the firm’s MARR is 15%, make a recommendation
as to the desirability of installing the new equipment and indicate the best
:course of action under the following three cases

a) When the annual increase in the operating and maintenance costs

of the present equipment, x, is $750.
b) When x = $800
c) When x = $0.0

Solution

The cash flow diagram for both defender and challenger are shown
:below

$55,000

$25,000 $20,000

3- 0 1 7 i = 15%
years
$1000
x+$1000
$60,000 $1000+6x M&O = $6575
i = 15%
$90,000

Cash flow diagram for Defender Cash flow diagram for

$80,000 challenger

The defender’s salvage value deprecates linearly, hence

$ S .V  60000  5000n

:The annual maintenance and operation cost (M&O) for the defender is

A / G i,n
$ M & O  10000  x( )

The general expression of the total equivalent annual cost (TEA) for the
:defender is as follows
 A/ P i n
TEA(n) I  ( P  S .V )( )  S .V  i  M & R

A / P 15, n A / G 15, n
TEA(n) I  5000n( )  (60000  5000n)  0.15  10000  x( )

A / P 15, n A / G 15, n
TEA(n) I  19000  5000n( )  750n  x( )

The general expression of the total equivalent annual cost (TEA) for the
:challenger is as follows
A/ P i n
TEA(n) II  ( P  S .V )( )  S .V  i  M & R

A / P 15, n
TEA(n) II  (80000  20000)( )  20000  0.15  6575

A / P 15, n
TEA(n) II  60000( )  9575

The following table shows the values of TEAI and TEAII for various
values of n

n A / P 15, n A / G 15 , n ($) TEAI TEAII

( ) ( )
(years) x  750 x  800 x0 ($)
1 1.1500 0 24000.000 24000.000 24000.0 78575
2 0.6151 0.4651 23999.825 24023.080 23651.0 46481
3 0.4380 0.9071 24000.325 24045.680 23320.0 35855
4 0.3503 1.3263 24000.725 24067.040 23006.0 30593
5 0.2983 1.7228 23999.600 24085.740 22707.5 27473
*
6 0.2642 2.0972 23998.900 24103.760 22426.0 25427
7 0.2404 2.4498 24001.350 24123.920 22164.0 23999

The numbers in blue represent the machines’ (TEA) at their economic *

life

:Recommendations

:Case (a)

Use old machine for six years, or replace it and use the new
one for seven years
 :Case (b)
Replace the old machine

:Case (c)
Use the old machine for 7 years

Problem 7.3
A manufacturer of cans and packaging for the food industry is
considering the replacement of some of its current production
equipment . The equipment presently in operation was installed three
years ago at a cost of $90,000 with estimated service life of 10 years and
can presently be sold for $60,000 . The salvage value of the present
equipment after one year is estimated to be $55,000 and is expected to
decline uniformly by $5,000 a year . If the present equipment is retained
one more year , its operating and maintenance cost are expected to be
$10,000 with uniform annual increase of “X” dollars every year thereafter
, where the numerical values of “X” are given below . The new
equipment will cost $80,000 . Its economic life is predicted to be 7 years
with salvage value of $20,000 . Annual operating and maintenance cost
for new equipment will remain constant at $6,575 . If the firm’s MARR is
15% , make a recommendation as to the desirability of installing the new
equipment and indicate the best course of action under the following
: three cases

a) When the annual increase in the operating and maintenance costs of the
. present equipment , x , is $750
b) When x = $800
c) When x = $0.0
Solution

$20000

55000 50000
45000

years 7 0

years 7

$10000 $6575
x+$10000
$10000+2x
$60000
$80000
$90,000
 TEA = (P-SV)( A / G i, n ) + SV(i) + M&O
( i, n A / G )SV = 10000 + x
A / G )TEA (n)= 5000n ( A / P 15, n ) + (60000-5000n)(0.15) + 1000 + x

( 15, n
( 15, n A / G )TEA(n) = 19000 + 5000n ( A / P 15, n ) – 750 + x
( 15, n A / G )TEA(n) = 19000 + 5000n ( A / P 15, n ) – 750n + x

TEA
19000-750n + 15, n A / G )
N ( 15, n A/ P )
( 15, n A / P )5000 (
X=700 X=750 X=800

1 1.1500 2400 0.0000 24000 24000 24000

23976.5
2 0.6151 23651 0.4651 23999.825 24623.08
7
23954.9
3 0.4380 23320 0.9071 24000.325 24045.68
7
23934.4
4 0.3503 23006 1.3263 24000.725 24067.04
1
23913.4
5 0.2983 22707.5 1.7228 23999.6 24085.74
6
23894.0
6 0.2642 22426 2.0972 23998.9 24103.76
4
23878.9
7 0.2404 22164 2.4499 24001.425 24123.92
3
23862.9
8 0.2229 21916 2.7813 24001975 24141.04
1

TEA=( 0A.2404
/ P 15,7
)+20,000(0.15)+6575=$23999

i) x = $700  use old m/c for 7 year.

ii) x =$750  use old m/c for 6 year.
iii) x =$800  replace.

Problem 7.4
Two earth moving machines are being considered for purchase by a construction
company .Both machines have the capacity required but the giant is heavier
and more rugged than the Trojan and it is believed it will have a longer life.
:Estimates of the matters that will be influenced by the choice are as follows

Trojan Giant

First cost delivered $30,000 $60,000

Maintenance cost in first year of a machine's service 8.000 5,000
Annual increase in cost of maintenance during the achine's lif 5,000 400
Physical life y years years 6
Terminal salvage value $15,000 400

.The interest rate is 12% compounded annually

a ) If the giant machine depreciates linearly while the Trojan has a constant
salvage value of 50 per cent of its first cost at any time t(svt=0.5p)
determine
. the economic lives of the two machines

b) which machine do you recommend and what is its and annual economic
?advantage over the other

:Solution
A|P i,n
TEAn= (P-SVn)*( ) +Svn(i)+M&O
:For Trojan

SVn=0.5P=0.58*($30000) =$15000
A/G 12, n
M&0=8000+5000( )
A/P 12,n A/G 12,n
T= (30000-1500)*( )+1500(0.12)+8000+5000( ) (TEA )
A/P 12,n A/G 12,n
T=$9800+1500( )+5000( ) (TEA )*

:For Giant
SVn=P-n*(60000-6000)/6=P-9000n
P-(P-9000n) =9000n=(P-SVn)
A/G 12, n
M&O=5000+400( )
A/P 12, n A/G 12, n
G=9000(n) ( ) + (60000-9000n)*(0.12) +5000+410( ) (TEA)
A/P 12, n A/G 12, n
G=12200+9000n ( ) +400( ) -1080n (TEA)

:For Trojan
Nec = 3 years
T Min = $20,669(TEA)

Fo
n r
(TEA ) (TEA )
A/G 12, n A/P 12, n
year ( ) ( ) T G Gi
ant
1 0.0000 1.1200 26,600 21,200 :
2 0.4717 0.5917 21,026.5 20,879.23

3 0.9246 0.4164 20,669 20,572.64

4 1.3589 0.3272 21,532.5 20,274.76

5 1.7746 0.2774 22,834 19,992.84

6 2.1721 0.2432 24,308.5 19,731.64

Nec = 6 years
G Min =$ 19,721(TEA)

Giant is better , it has an annual economic advantage (saving) of

947 $= $19,721 - $20,669

Trojan

Giant

Problem 7.5

The three Stars Company has an old heat exchanger that has to be
repaired or replaced by a new one. Assuming that the company has a
minimum attractive rate of return, MARR, of 15%, solve questions (a)
:and (b) below
If the cost of the new heat exchanger is $12.000 and it lasts 8 years (a)
with zero salvage value, how much can be spent now in a repair of the old
.heat exchanger that extends its life by 4 years

If an amount of $5.000 is sufficient to repair the old heat exchanger so (b)

:that its service life is extended by 4 years, determine the following
i) The maximum amount that can be spent on a new heat exchanger
that provides
.service for 8 years
ii) The minimum service life for a new heat exchanger that costs
.$12.000

Suppose that the Three Stars Company has purchased the new heat (c)
exchanger specified in part (a) from a manufacturer who guaranteed its
equipment for 8 years and also agreed to accept money investing rate of
15%.If the purchased heat exchanger becomes worthless at the end of the
?6th year, how much refund should be paid to the Three Stars Company

If the Three Stars Company finds that spending $5.000 on repairing to (d)
obtain a 4 – year life is equally attractive as spending $7.000 on repairing
to obtain a 6 – year life, determine the rate at which the company invest
.money

I=15%
.a)P=$12000,SV=0,SL=8 years
.After repairing the old exchanger, it gains 4 years in service life

:For the new machine, AE(i) is calculated for a period of 8 years

0.22285 =(A/P 15,8)=(A/P i, n)
AE(i) = P * (A/P 15,8) = 12000 * 0.22285 = $ 2674.2 (1)

As for the old exchanger, we calculate its annual equivalent for 4 years
:with an unknown (x) value of first cost
0.35026= (A/P 15,4)
AE(i)= x * (A/P 15,4) = .35026 x (2)

:By equating (1) and (2),we can get the value of x

35025x = 2674.2.
x= $ 7640.57
.which is the amount to be paid for the repair of the old exchanger

b) for the old exchanger ,P= $5000 and S.L=4

AE(i)= $5000 * (A/P 15,4) = $ 1751.32 (1)

:i]for the new exchanger

P= x, S.L = 8
AE(i)= x (A/P 15,8) = 0.22285x (2)

:Again, by equating (1) and (2) we get

0.22285x=1751,32
x= $ 7858,73 = price of new exchanger

ii]this time around, the value of the exchanger is known while its service
..life is to be found
:by repeating the same processes as above we get
1751.32 = (A/P 15,n)*12000
0.401=(A/P 15,n)
this value of the interest factor is found from to fall in between the -
values for (A/P 15,4) and (A/P 15,5), leading to the use of interpolation in
:the following sequence

Y=(A/P 15,n),Y1=(A/P 15,4),Y2=(A/P 15,5),X=n,X1=4,X1=5

.Which gives us the value of N= 4.7 years

c) here we have a situation where a portion of the initial service life has
been omitted due to a failure in the machine since its original service life
was 8 years and only for 6 out of those 8 years was the machine operable,
thus incurring a loss in the investment to be refunded by the manufacturer
.who had sold the company the machine

In the beginning, we get the original annual equivalent of the machine

AE1(i) = 12000* (A/P 15,8) = $2674.20

And since the refund would –naturally- be paid on the year of the
malfunction, which is the 6th year, we find the value of the lost 2 years at
.year 6

AE(i) * (A/P 15,2) = 2674.2 * 1.6257 = $4347.4707 =

.Which is the amount of the refund to be paid to refund
d) now, we are given 2 alternatives having the same annual equivalent
.values but with different service lives and the interest rate (i) is required

Alt1= 5000*(A/P i,4)

Alt2=7000*(A/P i,6)
:And since those 2 alternatives are equivalent
(*) Alt1 = Alt2 5000*(A/P i,4) = 7000*(A/P i,6)

Through the use of the MATLAB programming environment, the 2 sides

of the equation have been plotted and the point where their values are
equal was found to be located at i= 0 .076 or 7.6%

.(refer to enclosed plot)

PROBLEM (7.5)

The Three Stars Company has an old heat exchanger that has to be
repaired or replaced by a new one. Assuming that the company has a minimum
attractive rate of return, MARR, of 15%, solve the questions below:

a) If the cost of the new heat exchanger is $12,000 and it lasts 8 years with
zero salvage value, how much can be spent now in a repair of the old heat
exchanger that extends its life by 4 years?

b) If an amount of $5,000 is sufficient to repair the old heat exchanger so

that its service life is extended by 4 years, determine the following:-

i. The maximum amount that can be spent on a new heat

exchanger that provides service for 8 years.
ii. The minimum service life for a new heat exchanger that costs
$12,000.

c) Suppose that the Three Stars Company has purchased the new heat
exchanger specified in Part (a) from a manufacturer who guaranteed its
equipment for 8 years and also agreed to accept money investing rate of 15%. If
the purchased heat exchanger becomes worthless at the end of the 6th year, how
much refund should be paid to the Three Stars Company?

d) If the Three Stars Company finds that spending $5,000 on repairing to

obtain a 4-years life is equally attractive as spending $7,000 on repairing to
obtain a 6-years life, determine the rate at which the company invest money?

SOLUTION

PART (A):
 0 1 2 3 4 5 6 7 8 years

AE(15) new = ?????

= 15%

Pnew = $12,000

the annual equivalent cost – AE(15)new - for the new heat exchanger
A/ P i, n
AE(i)new = Pnew ( )
Where:-
Pnew ≡ current cost of the new heat exchanger = $12,000
i = MARR = 15%
n = 8 years

then:
A/ P 15 , 8
AE(15)new = $12,000 x ( )
from the tables:

A/ P 15 , 8
( )= 0.2229

Therefore:-
A/ P 15,8
AE(15)new = $12,000 x ( 0.2229 ) = $2,674.8
The maximum amount to be spent on the repair of the old heat exchanger
must not make its annual equivalent – AE(15)old - exceed the annual equivalent of
the new one - AE(15)new - , or else the repair operation would have not be
economically advisable.
 the maximum
1 2
amount occurs 4when:
3
AE(15)old = AE(15)new
years
0

AE(15) new = $2,674.8

= 15%
Pold = ?????
 P/A i, n
Pold = AE(i)old ( )
Where:
AE(15)old = AE(15)new = $2,674.8
i = MARR = 15%
n = 4 years

then:
P/A 15, 4
Pold = $2,674.8x ( )
from the tables:

P/A 15, 4
( )= $2.8550

Therefore:
P/A 15 , 4
Pold = $2,674.8x ( 2.8550 ) = $7,636.554
The maximum amount that can be spent now in a repair of the old heat
exchanger that extends its service life by no more than 4 years = $7,636.554. If
the service life of the old one can be lengthened by 4 years with an amount less
than that above- then it is better to repair than to buy the new one described. But
if it costs more then buying is a better option economically.

PART (B):
As before in (a) and since the service lives of the new and old heat
exchangers are not equal, the comparison can only be made by using the Annual
Equivalent Amount – AE(i) – as a base of comparison.

1 2 3 4 years
0

AE(15) old = ????

= 15%
Pold = $5,000
 A/ P i, n
AE(i)old = Pold ( )
Where:-
Pnew = $5,000
i = MARR = 15%
n = 4 years

then:
A/ P 15, 4
AE(15)old = $5,000 x ( )
from the tables:

A/ P 15 , 4
( )= 0.3503

Therefore:-
A/ P 15 , 4
AE(i)old = $5,000 x ( 0.3503 ) = $1,751.5
[i]
As explained above, the maximum amount that can be spent in buying the
new heat exchanger must not make the annual equivalent – AE(15)new – exceed
that of the old one - AE(15)old.
To calculate the maximum amount, put: AE(15)new = AE(15)old

0 1 2 3 4 5 6 7 8 years

AE(15) new = $1,751.5

= 15%

Pnew(MAX) = ?????

P/A i, n
Pnew(MAX) = AE(15)new ( )
Where:
AE(15)new = AE(15)old = $1,751.5
i = MARR = 15%
n = 8 years

then:
 P/A 15, 8
Pnew(MAX) = $1,751.5x ( )
from the tables:

P/A 15 , 8
( )= 4.4873

Therefore:
P/A 15 , 8
Pnew(MAX) = $1,751.5x ( 4.4873 ) = $7,859.5
-The price of the new 8-years-service-life heat exchanger must not exceed
$7,859.5

[ii]
Here we need to calculate the service life of the new heat exchanger (n)
that would make the two heat exchangers equivalent to each other economically.
i.e. AE(15)old = AE(15)new
0 1 2 3 4 5 6 n-1 n years

AE(15) new = $1,751.5

m = 15%

Pnew= $12,000

P/A i, n
Pnew = AE(15)new ( )
Where:
AE(15)new = AE(15)old = $1,751.5
Pnew = $12,000
i = MARR = 15%
n = ?? years

The expression above becomes:

P/A 15 , n
$12,000 = $1,751.5 x ( )
P/A 15, n
( ) $12,000
$1,751.5
 6.85127  (i )

From the interest formula:

P/A 15, n
(1  i ) n  1 (1  0.15) n  1
( )   6.85127
i (1  i ) n 0.15 (1  0.15 ) n
 (1.15) n  1  6.85127  0.15 (1.15) n
1.0277 (1.15) n   1  (1.15) n   0.973
--Which has no solution within the acceptable range of n (the number of
years cannot be a negative or an imaginary number!).
Going back to (i):-
P/A 15 , n
( )  6.85127

But it is already known from the limiting values for the factors (refer to
page 258 in "Engineering Economy" textbook)

P/A 15 , n
lim n   ( ) 6.6667

-- Which is less than the desired value of 6.85127

From another view:
Interest per year = P * i = $12,000 * 0.15 = $1,800 > $1,751.5
So by taking $1,751.5 uniform payments annually from the $12,000, the
capital will not diminish, but rather it is increasing; with the current interest rate
it is impossible to distribute the $12,000 into uniform payments of $1,751.5 even
if we extend the time into infinity.

Bottom-line, even if we expected the service life of the new heat exchanger
to be infinity, it is not enough. In all circumstances repairing the old heat
exchanger is more economically attractive than buying a new one with $12,000
no matter how long its service life is.

PART (C):
By distributing the initial cost of the new heat exchanger over the entire
estimated 8 years of its service life, the value that remains in the heat exchanger
at the end of the 6th year is the fund that must be returned to the Three Stars
Company.

0 1 2 3 4 5 6 7 8 years

AE(15) new = ?????

Prefund = ???
= 15%
Pnew= $12,000

from a) above:-
 AE(15)new = $2,674.8

P/A i, n
Prefund = Anew ( )
Where:-
Anew = $2,674.8
i = MARR = 15%
n = 2 years

then:
P/A 15 , 2
Prefund = $2,674.8 x ( )
from the tables:

P/A 15 , 2
( )= 1.6257

Substituting the numerical values we obtain:

P/ A 15 , 2
Prefund = $2,674.8x ( 1.6257 ) = $4,348.422
---The manufacturer should pay to the Three Stars Company : $4,348.422

PART (D):

For the two alternatives to be equally attractive economically, their

annual equivalents -AE(i) - must be equal .[AE(i) is chosen because of the
different service lives]

for the 4-years alternative:

1 2 3 4
years
0

AE(i) I = ?????

= ???

PI= $5,000
 i, n
A/ P
AE(i)I = PI (
I
)
Where:
PI ≡ present worth = $5,000
nI = 4 years

Then:
A/ P i ,4
AE(i)I = $5,000 x ( )

for the 6-years alternative:

0 1 2 3 4 5 6
years

AE(i) II = ?????

m = ???

PII= $7,000

i, n
A/ P
AE(i)II = PII (
II
)
Where:
PII ≡ present-worth = $7,000
nII = 6 years

Then:-
A/ P i ,6
AE(i)II = $7,000 x ( )
And the break-even point occurs when:-
AE(i)I = AE(i)II


A/ P i ,6 A/ P i ,4
$7,000 x ( ) = $5,000 x ( )
 A/ P i ,4
( )  1.4  (
A/ P i ,4
)  1.4  (
A/ P i ,6
)
A/ P i ,6
( )
( i  1) 4 i (i  1) 6 i ( i 4  4i 3  7i 2  6i  0.5)(i  1) 4
 1 . 4   0
(i  1) 4  1 (i  1) 6  1 ( i 5  6i 4  15i 3  20i 2  15i  6)(i 2  2i  2)i
0.5  i 8  8i 7  29i 6  62i 5  82.5i 4  66i 3  28i 2  4i  0
An 8-th order equation that has 8 solutions: 7 of them are unacceptable (either
imaginary or negative)
The only acceptable solution is: i = 0.07625 = 7.625%

-- The rate at which the company invests money is i = 7.625%