iHe Inc. has several he extractor evaporators that were purchased four years ago at a price of...

Question

iHe
Inc. has several he
extractor evaporators that were purchased four years ago at a price of $20,000. These machines cu
ently require annual maintenance costs of $2,000. However, the maintenance agreement with the manufacturer expires at the end of two years and iHe
expects annual maintenance to increase to $8,000 per year thereafter. The machines could be sold at the cu
ent year in marketplace, as is, for $8,000, but the expected sale price will decline to $3,500 at the end of two years. At the end of year 6, the machine's useful life will be over and they will be disposed of as valueless scrap.
iHe
is considering replacing these evaporators with a new machine that will accomplish the same job. The cost of the new machine is $25,000 and the manufacturer offers an 8-year maintenance contract of $1,000 per year. This machine will have an 8-year life and be worthless scrap at the end. Assume both equipment (new & old) is depreciated using 7-yr straight-line depreciation and has a tax rate of 39% (i.e., the old machine still have 4 years depreciation left). At a cost of capital of 7% (assume zero inflation), when should iHe
replace its evaporators?

(Hint: To make decision on whether and when iHe
shall replace the old machine, you would want to compare (1) EAC of continue operating the old machine (2) EAC if replace the old machine now with new machine (3) EAC if wait till end of year 2 to replace the old machine with new machine. (4) EAC if replace the machine till end of year 6)

Project Submission Instructions:
Please use an Excel file with all relevant information clearly laid out. For each scenario, you would want to clearly lay out all the relevant cash flows, numbers that are not directly given by the case but are calculated based on case information shall be reflected in Excel as results of calculated number (i.e., I shall be able to see the underlying formula the number is a
ived by clicking on the cell—Do not just paste numbers in the submitted file as results of your calculation elsewhere). Please try to lay out the information and steps in a clear and organized way.
Have a final conclusion statement in bold font regarding whether and when shall iHea
replace its evaporators and
iefly mention why.

iherb-inc-v2gxnotb.docx

Sanzil · Accepted Answer

Solution
			Price						New
	Purchase 	4 years ago 	20,000					purchase	25,000
	AMC for first 2 years 		2,000					AMC for 8 years	1,000
	AMC after from 3rd year onwards 		8,000					Selling price after 8 year	- 0
	Selling price after 2 year		8,000
	Selling price after 4 year		3,500					Depriciation 	3,571
	Selling price after 6 year	scrap 	- 0					Life 7 Year as mentioned  in question 
	Depriciation 		2,857
	Life 7 Year as mentioned  in question 
	dep 	7 year 	SLM
	tax rate	39%
	COC 	7%
	Q1
	Year	AMC	Depriciation 	Tax benefit on depriciation	Net outflow	Discount rate	Net Cash outflow 
	1	2,000	2,857.1	1,114.3	885.71	1.000	885.71
	2	2,000	2,857.1	1,114.3	885.71	0.935	827.77
	3	8,000	2,857.1	1,114.3	6,885.71	0.873	6,014.25
	4	8,000	2,857.1	1,114.3	6,885.71	0.816	5,620.79
	5	8,000	2,857.1	1,114.3	6,885.71	0.763	5,253.08
	6	8,000	2,857.1	1,114.3	6,885.71	0.713	4,909.42
						Total PV of cash outflow 	23,511
						Machine cost	20,000
						Total 	43,511
						Outflow per year	7,252
	Q2
	Assuming we are standing at the end of Year 4 (refer 1st line of the question)
	Year	Machine 1	Machine 2	Total 	Remarks 
	0	20,000	- 0	20,000
	1	886	- 0	886
	2	828	- 0	828
	3	6,014	- 0	6,014
	4	1,149	20,407	21,557	 Note :Resale of machinery 1 at end of 4th Year 
	5	- 0	-300	-300
	6	- 0	-280	-280
	7	- 0	-262	-262
	8	- 0	-245	-245
	9	- 0	-229	-229
	10	- 0	-214	-214
	11	- 0	-200	-200
	12	- 0	-187	-187
			Net Cash outflow if old machine is replaced 	47,369.49
			Outflow per year	3,947.46
	Q3
	Year	Machine 1	Machine 2	Total 	Remarks 
	0	20,000	- 0	20,000
	1	886	- 0	886
	2	-8,940	23,364	14,

iHerb Inc. has several herb extractor evaporators that were purchased four years ago at a price of $20,000. These machines currently require annual maintenance costs of $2,000. However, the...

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