- 10 Marks
FM – Nov 2020 – L2 – Q4a – DCF: Specific applications
Determine the optimal replacement cycle length for the machine using the equivalent annual cost method at Rock Beverages Ltd (RBL)
Question
a) Rock Beverages Ltd (RBL) is a producer of fresh fruit juice. RBL operates a fruit juice extracting machine, which costs GH¢150,000 to purchase and GH¢10,000 to install. The efficiency of the machine reduces over time. Consequently, the costs associated with its use increase over time. Two costs that are influenced by the level of efficiency of the machine are operational costs and maintenance costs. Operational costs are estimated to be GH¢30,000 during the first year of the machine’s use; GH¢35,000 during its second year; and GH¢40,000 during its third year. Maintenance costs are estimated to be GH¢11,000 during the first year of the machine’s use; GH¢13,000 during its second year; and GH¢15,000 during its third year. The resale value of the machine is GH¢40,000 at the end of the first year of use; GH¢35,000 at the end of the second year of use; and GH¢28,000 at the end of the third year of use. RBL’s cost of capital is 18%.
Required:
Determine the optimal replacement cycle length for the machine using the equivalent annual cost method. (10 marks)
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