Sample Problems for Replacement Studies

1. A man wants to know whether he will retain his old LED TV or buy a new one. The old
TV was bought four years ago at a cost of P75,000. If he sells it today, he can get a price of
P51,000. The old TV can still last for seven years at which time it can be sold at a price of
P6,000. Its annual operating cost is P5,000. While the new TV costs P81,000, and can be
sold at P11,000 at the end of a life of 11 years. Its annual operating cost is P3,000. Using
Annual Equivalent Cost Method, should he retain the old TV? Assume the interest rate is
10%.

Solution:

Note: Cash flow diagram shown

for the New TV is wrong. It
needs to be extended up to 11
years.

( 1+i )n ( i ) i
AEC old = A o+C L i
( n
(1+i ) −1 ) −C L (
f
( 1+i )n−1
)

( 1.1 )7 ( 0.1 ) 0.1

AEC old =5,000+51,000
( 7
( 1.1 ) −1 ) −6,000(
( 1.1 )7−1
)

AEC old =P 14,843

( 1+i )n ( i ) i
AEC new = A o+C o
( n
( 1+i ) −1
−C L (
)( 1+i )n−1
)
 ( 1.1 )11 ( 0.1 ) 0.1
AEC new =3,000+81,000
( 11
(1.1 ) −1 ) −11,000(
( 1.1 )11−1
)

AEC new =P 14,877

AEC new is almost the same as that of AEC old , either choice is acceptable.

2.An old machine was bought 3 years ago for P100,000 and can be sold now for P75,000. It has a
remaining life of 8 years, an annual operating cost of P23,000 and a salvage value of
P10,000. There is a plan to replace the old one with a new machine costing P150,000, with
an annual operating cost of 10,000, no salvage value, and a life of 8 years. Should the old
machine be replaced? Assume an interest of 10%.

Solution:

( 1+i )n ( i ) i
AEC old = A o+C Li
( n
(1+i ) −1 ) (
−C L
( 1+i )n−1
f
)
( 1.1 )8 ( 0.1 ) 0.1
AEC old =23,000+75,000
( 8
( 1.1 ) −1) −10,000(
( 1.1 )8−1
)

AEC old =P 36,183.86

( 1+i )n ( i ) i
AEC new = A o+C o
( n
( 1+i ) −1 )
−C L (
( 1+i )n−1
)

( 1.1 )8 ( 0.1 )
AEC new =10,000+150,000
( 1.1 )8−1 ( )
 AEC new =P 38,116.6

Therefore, since AEC new > AEC old, retain the old machine.

3. A construction company wants to replace an old pump that has an initial salvage value of
25,000, a final salvage value of 3,000. The old pump still has a life of 5 years and has an
annual operating cost of 7,000. The new pump costs 30,000 and has a salvage value of
5,000. The new pump also has a life of 5 years and an annual operating cost of 6,000.
Assume an interest of 20%. Decide what to do?

Solution:

( 1+i )n ( i ) i
AEC old = A o+C L i
( n
(1+i ) −1 ) ( −C L
f
( 1+i )n−1 )
( 1.2 )5 ( 0.2 ) 0.2
AEC old =7,000+25,000
( 5
( 1.2 ) −1) −3,000
(
( 1.2 )5−1 )
AEC old =P 54,274.8

( 1+i )n ( i ) i
AEC new = A o+C o
( n
( 1+i ) −1 ) −C L (
( 1+i )n−1
)

( 1.2 )5 ( 0.2 ) 0.2

AEC new =5,000+30,000 5(
( 1.2 ) −1
−7,500
)
( 1.2 )5−1 ( )
AEC new =P 54,235

Therefore , since the difference between AEC new ∧ AEC old is negligible, either choice
is acceptable.