11 Park ISM ch11 PDF

11-1
Part 4
Special Topics in
Engineering Economics
Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

11-2
Chapter 11 Replacement Decisions
Sunk Costs, Opportunity Costs, and Cash Flows
11.1
(a) Purchase price = $18,000

Market value = $7,000
Sunk cost = $11,000
(b) Opportunity cost = $7,000
(c) Operating the truck for two years
MARR= 15%
N= 2
year: 0 1 2
Cost: -1,500 -3,000 -3,500
SV: -7,000 3,000
Net: -8,500 -3,000 -500
NPV: -$11,486.77
AEC: $7,065.70
(d) Operating the truck for five years:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Cost: -1,500 -3,000 -3,500 -3,800 -4,500 -9,800
SV: -7,000 0
Net: -8,500 -3,000 -3,500 -3,800 -4,500 -9,800
NPV: -$23,698.98
AEC: $7,069.77

11-3
11.2
(a) Opportunity cost = $35,000
(b) Assume the operating cost of the defender is $30,000 per year. Then the
operating cost of the challenger is $0 each year. Keeping the defender for two
years:
MARR= 12%
N= 2
year: 0 1 2
Cost: -30,000 -30,000
SV: -35,000 12,000
Net: -35,000 -30,000 -18,000
NPV: -$76,135.20
AEC: $45,049.06
(c) Using the challenger for eight years:
MARR= 12%
N= 8
year: 0 1 2 3 4 5 6 7 8
Cost:
SV: -175,000 5,000
Net: -175,000 0 0 0 0 0 0 0 5,000
-
NPV: $172,980.58
AEC: $34,821.48
(d) Since AEC of defender is larger than AEC of challenger, replace the defender
now.

11-4
*
11.3
(a) Initial cash outlay for the new machine = $130,000
(b) Cash flows for defender over five years:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Revenue:
Cost:
SV: -10,000 0
Net: -10,000 0 0 0 0 0
NPV: -$10,000.00
AEC: $2,983.16
(c) Using the challenger for seven years:
MARR= 15%
N= 7
year: 0 1 2 3 4 5 6 7
Revenue: 50,000 50,000 50,000 50,000 50,000 50,00050,000
Cost:
SV: -130,000 30,000
Net: -130,000 50,000 50,000 50,000 50,000 50,000 50,00080,000
NAP: $89,299.10
AEC: -$21,463.96
The defender has an AEC of $2,983.16. The challenge has a positive AE of $21,463.96.
Replace the defender now.
*
An asterisk next to a problem number indicates that the solution is available to students
on the Companion Website.

11-5
11.4 (a)
Defender:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Revenue:
Cost:
SV: -10,000 5,000
Net: -10,000 0 0 0 0 5,000
NPV: -$7,514.12
AEC: $2,241.58
Challenger:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Revenue: 30,000 30,000 30,000 30,000 30,000
Cost:
SV: -85,000 0
Net: -85,000 30,000 30,000 30,000 30,000 30,000
NPV: $15,564.65
AEC: -$4,643.18
(b) Since defender has an AEC of $2,241.58 while challenger has an AE of $4,643.18,
replace the defender now.

11-6
11.5
Defender: Annual profit = $(19 12)*3,000 = $21,000
MARR= 12%
N= 3
year: 0 1 2 3
Revenue: 21,000 21,000 21,000
Cost:
SV: -6,500 1,200
Net: -6,500 21,000 21,000 22,200
NPV: $44,792.59
AEC: -$18,649.35
Challenger: Annual profit = $(19 11)*3,000 = $24,000

MARR= 12%
N= 5
year: 0 1 2 3 4 5
Revenue: 24,000 24,000 24,000 24,000 24,000
Cost:
SV: -35,500 6,300
Net: -35,500 24,000 24,000 24,000 24,000 30,300
NPV: $54,589.42
AEC: -$15,143.64
The defender has an AE value of $18,649.35, which is larger than the AE value of
$15,143.64 of the challenger. Keep the defender for now.

11-7
Economic Service Life

11.6
Defender:
MARR= 12%
Year OC MV AEOC CR AEC

0 7,900
1 3,200 4,300 3,200 4,548 7,748
2 3,700 3,300 3,436 3,118 6,554
3 4,800 1,100 3,840 2,963 6,803
4 5,850 0 4,261 2,601 6,862
The defender's economic life is two years with AEC = $6,554.
Challenger:
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9 10
Revenue:
-
Cost: -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 1,000
SV: -32,000 2,500
Net: -32,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 1,500
NPV: -$36,845
AEC: $6,521
Since the AEC of the defender is larger, replace it now.

11-8
11.7 Challenger:
(a)
MARR= 12%
Year OC MV AEOC CR AEC AE

0 7,500 0
1 -4,000 4,200 -4,000 4,200 200 -200
2 -3,400 2,940 -3,717 3,051 -666 666
3 -2,710 2,058 -3,419 2,513 -906 906
4 -1,917 1,441 -3,104 2,168 -936 936
5 -1,004 1,008 -2,774 1,922 -852 852
6 45 706 -2,426 1,737 -689 689
7 1,252 494 -2,062 1,594 -467 467
The economic life is four years with the largest AE of $936.
(b)
Interest rate Economic life Maximum AE value

1% 3 years 1503
5% 3 years 1290
10% 4 years 1033
12% 4 years 936
15% 4 years 788
20% 4 years 534
25% 4 years 270
30% 5 years 14
40% 5 years -515
The maximum annual revenue at its economic service life varies inversely with the
interest rate.
The economic service life increases as the interest rate increases in our example. As the
interest rate increases, the capital cost will also increase. However, the annual equivalent
revenue will decrease. Thus, the net effect is that the marginal increase in the capital cost
is less than the decrease in the annual equivalent revenue, resulting in extending the
service life.

11-9
*
11.8
(a)
MARR= 10%

0 18,000
1 2,500 14,400 2,500 5,400 7,900
2 3,250 11,520 2,857 4,886 7,743
3 4,225 9,216 3,270 4,454 7,724
4 5,493 7,373 3,749 4,090 7,839
5 7,140 5,898 4,305 3,782 8,087
At 10%, the economic life is three years with AEC = $7,724.
(b)
MARR= 20%

0 18,000
1 2,500 14,400 2,500 7,200 9,700
2 3,250 11,520 2,841 6,545 9,386
3 4,225 9,216 3,221 6,013 9,234
4 5,493 7,373 3,644 5,580 9,224
5 7,140 5,898 4,114 5,226 9,340
At 20%, the economic life is four years with AEC = $9,224.

11-10
Replacement Decisions With an Infinite Planning Horizon and No Technological Change

*
11.9
Defender:
MARR= 8%
N= 6
year: 0 1 2 3 4 5 6
Revenue:
Cost: -2000 -2000 -2000 -2000 -2000 -2000
SV: -6,000 1500
Net: -6,000 -2000 -2000 -2000 -2000 -2000 -500
NPV: -$14,300.50
AEC: $3,093.42
Challenger:
MARR= 8%
N= 12
year: 0 1 2 3 4 5 6 7 8 9 10 11 12
Revenue:
Cost: -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000
SV: -23,000 500
Net: -23,000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -1000 -500
NPV: -$30,337.52
AEC: $4,025.64
Keep using the defender. The economic advantage is: $932.22 per year = $4025.64 $3093.42

11-11
11.10
Defender:
MARR= 15%
N= 3
year: 0 1 2 3
Revenue:
Cost: -3,000 -4,500 -6,000
SV: -4,000 1,000
Net: -4,000 -3,000 -4,500 -5,000
NPV: -$13,298.92
AEC: $5,824.62
Challenger:
MARR= 15%
N= 3
year: 0 1 2 3
Revenue:
Cost: -2,000 -3,000 -4,000
SV: -7,000 2,000
Net: -7,000 -2,000 -3,000 -2,000
NPV: -$12,322.59
AEC: $5,397.01
Replace the defender because the challenger has a lower AEC value.

11-12
11.11
(a) Opportunity cost = $0
(b) Incremental cash flows:
MARR= 10%
N= 5
year: 0 1 2 3 4 5
Revenue: 3,000 3,000 3,000 3,000 3,000
Cost:
SV: -11,000 0
Net: -11,000 3,000 3,000 3,000 3,000 3,000
NPV: $372.36
AEC: -$98.23
IRR: 11.3%
(c) Incremental IRR = 11.3% > MARR = 10%. Buy the new machine.

11-13
11.12
Defender:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Revenue: 10,000 10,000 10,000 10,000 10,000
Cost: -7,000 -7,000 -7,000 -7,000 -7,000
SV: -2,000
Net: -2,000 3,000 3,000 3,000 3,000 3,000
NPV: $8,056.47
AEC: -$2,403.37
Challenger:
MARR= 15%
N= 5
year: 0 1 2 3 4 5
Revenue: 11,500 11,500 11,500 11,500 11,500
Cost: -5,000 -5,000 -5,000 -5,000 -5,000
SV: -15,000 2,000
Net: -15,000 6,500 6,500 6,500 6,500 8,500
NPV: $7,783.36
AEC: -$2,321.90
The new machine should not be purchased now because it has an AE value of $2,321.90,
which is lower than the AE value of $2,403.37 of the defender.

11-14
11.13
Defender:
MARR= 14%
N= 5
year: 0 1 2 3 4 5
Revenue:
Cost: -20,000 -20,000 -20,000 -20,000 -20,000
SV: -901,05.12 0
Net: -901,05.12 -20,000 -20,000 -20,000 -20,000 -20,000
NPV: -$158,766.74
AEC: $46,246.14
Challenger:
MARR= 14%
N= 10
year: 0 1 2 3 4 5 6 7 8 9 10
Revenue:
Cost: -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000
SV: -220,000 18,000
Net: -220,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000 13,000
NPV: -$241,225.19
AEC: $46,246.14
If the resale value of the old machine is $90,105.12, the two options would have the same AEC value.
If it is lower than $90,105.12, the defender is better; otherwise, the challenger is better.

11-15
*
11.14
Defender:
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9
Revenue:
Cost: -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18
SV: -60,000
Net: -60,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18
NPV: -$161,704
AEC: $28,619
Challenger:
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9
Revenue:
Cost: -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4
SV: -180,000 20
Net: -180,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 -4,000 16
NPV: -$196,161
AEC: $34,717
The AEC of the new process is $34,717, higher than the AEC of the current process of
$28,619. Keep the current process.

11-16
11.15
Defender:
MARR= 12%
N= 5
year: 0 1 2 3 4 5
Revenue:
Cost: -8,700 -8,700 -8,700 -8,700 -8,700
SV: -8,500 0
Net: -8,500 -8,700 -8,700 -8,700 -8,700 -8,700
NPV: -$39,862
AEC: $11,058
Challenger:
MARR= 12%
N= 5
year: 0 1 2 3 4 5
Revenue:
Cost: -4,200 -4,700 -5,200 -5,700 -6,200
SV: -52,000 12,000
Net: -52,000 -4,200 -4,700 -5,200 -5,700 5,800
NPV: -$63,529
AEC: $17,624
Keep the defender as it has a lower AEC value.

11-17
11.16
MARR= 10%
Year OC MV AEOC CR AEC AE

0 20,000
1 -23,620 17,000 -23,620 5,000 -18,620 18,620
2 -20,620 14,450 -22,191 4,643 -17,549 17,549
3 -17,170 12,283 -20,674 4,332 -16,343 16,343
4 -13,203 10,440 -19,064 4,060 -15,005 15,005
Year: 0 1
Market: -20,000 17,000
Revenue: 23,620
Net: -20,000 40,620
IRR= 103.10%
(a) The economic life is one year.

(b) The IRR with a one-year replacement cycle is 103.10%.

11-18
11.17
Defender:
MARR= 10%

0 2,000
1 3,800 1,500 3,800 700 4,500
2 3,800 1,200 3,800 581 4,381
3 3,800 960 3,800 514 4,314
4 3,800 768 3,800 465 4,265
5 3,800 614 3,800 427 4,227
The defender's economic life is five years with AEC = $4,227.
Challenger:
MARR= 10%
N= 12
year: 0 1 2 3 4 5 6 7 8 9 10 11 12
Revenue: 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000
Cost: -3,000-3,000-3,000-3,000-3,000 -3,000 -3,000-3,000 -3,000-3,000 -3,000 -3,000
SV: -49,000 3,000
Net: -49,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 6,000
NPV: -$27,603
AEC: $4,051
Replace the defender as the challenger has a lower AEC value.

11-19
11.18
Option 1: Keep the old sprayer
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9 10
Revenue:
Cost: -27000 -27000 -27000 -27000 -27000 -27000 -27000 -27000 -27000 -27000
SV: -55000 5000
Net: -55000 -27000 -27000 -27000 -27000 -27000 -27000 -27000 -27000 -27000 -22000
NPV: -$205,946
AEC: $36,449
Option 2: Sell the old sprayer
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9 10
Revenue:
Cost: -24000 -24000 -24000 -24000 -24000 -24000 -24000 -24000 -24000 -24000
SV: -85000 9000
Net: -85000 -24000 -24000 -24000 -24000 -24000 -24000 -24000 -24000 -24000 -15000
NPV: -$217,708
AEC: $38,531
Option 1 is better as its AEC is lower.

11-20
Replacement Problems With a Finite Planning Horizon

11.19
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8 9 10
Cost: 2550 2550 3250 3250 3250 3250 3250 3250 4280 4280 #1
NPV: $17,883
Cost: 3250 3250 3250 3250 3250 3250 3250 3250 3250 3250 #2
NPV: $18,363
Cost: 2700 2700 2700 3250 3250 3250 3250 3250 3250 5850 #3
NPV: $17,879
Cost: 2700 2700 2700 3250 3250 3250 3550 3550 3550 3550 #4
NPV: $17,504
Cost: 3350 3350 3350 3350 3250 3250 3250 3250 3250 3250 #5
NPV: $18,667
The five options considered above are:
Challenger
Option # Defender years years
1 2 3, 3, 2
2 1 3, 3, 3
3 3 3, 3, 1
4 3 3, 4
5 4 3, 3
It seems that Option 4 has the lowest PEC value of $17,504.
This option says, Keep defender for three years, replace it with a challenger for three
years, replace that with another challenger for four years.

11-21
11.20
Note: We aim to maximize the net present value (NPV) in this problem.
MARR= 12%
N= 10
year: 0 1 2 3 4 5 6 7 8
Revenue:
Revenue: 13850 13850 13850 13650 13650 13650 13050 13050 #1
NPV: $67,775
Revenue: 13550 13550 13650 13650 13650 13650 13650 13650 #2
NPV: $67,639
Revenue: 13450 13650 13650 13650 13650 13650 13650 12350 #3
NPV: $67,105
Revenue: 13250 13250 13250 13250 13650 13650 13650 12350 #4
NPV: $66,068
Revenue: 13250 13250 13250 13250 13450 13450 13450 13450 #5
NPV: $66,207
The five options considered above are:

Defender Challenger
Option # years years
1 3 3, 2
2 2 3, 3
3 1 3, 3, 1
4 4 3, 1
5 4 4
Since the values given are AE values, it seems that Option 1 is the best with the highest
NPV value.
This option says, Keep defender for three years, use a challenger for three years, and use
another challenger for two years.

11-22
11.21
Defender:
MARR= 11%
N= 6
year: 0 1 2 3 4 5 6
Revenue:
Cost: -4000 -4000 -4000 -4000 -4000 -4000
SV: -12000 2000
Net: -12000 -4000 -4000 -4000 -4000 -4000 -2000
NPV: -$27,853
AEC: $6,584
Challenger:
MARR= 11%
N= 6
year: 0 1 2 3 4 5 6
Revenue:
Cost: -2000 -2000 -2000 -2000 -2000 -2000
SV: -13000 -9000 4000
Net: -13000 -2000 -2000 -11000 -2000 -2000 2000
NPV: -$25,903
AEC: $6,123
The challenger should replace the defender now as it has a lower PEC value of $25,903.
Note: The SV value under year 3 is calculated as -$13,000 + $4,000 = -$9,000.

11-23
11.22
Based on the calculations given in Problem 11.21, the same conclusion can be made as
the challenger has a lower AEC value of $6,123.

11-24
Replacement Analysis With Tax Considerations

11.23
(a) Sunk cost can be defined as the past cost.

The original purchase price of $18,000 is a sunk cost.
(b) The opportunity cost of keeping the defender is the net market value today.
From (c), we see that it is equal to $7,000 + $199 = $7,199
(c) Keeping defender for two years:
Original Price= 18,000 t= 40%

Current Age= 3MARR= 15%
UCC= 7,497 N= 2
dE= 30%
Year 0 1 2
Income Statement
Revenues - -
Expenses
O&M 1,500 3,000 3,500
Overhaul
CCA @dE 2,249 1,574
Taxable income (1,500) (5,249) (5,074)
Income taxes @ t (600) (2,100) (2,030)
Net income (900) (3,149) (3,045)

Cash Flow Statement
Operating activities
Net income (900) (3,149) (3,045)

CCA - 2,249 1,574
Investment activities
Investment & Salvage (7,000) 3,000
Disposal tax effect (199) 269
Net cash flow (8,099) (900) 1,799
PE(MARR) = $ (7,521)
AE(MARR) = $ (4,626)
(d) Keeping defender for five years

11-25

UCC= 7,497 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 3,000 3,500 3,800 4,500 4,800
Overhaul 1,500 5,000
CCA @dE 2,249 1,574 1,102 771 540
Taxable income (1,500) (5,249) (5,074) (4,902) (5,271) (10,340)

Income taxes @ t (600) (2,100)(2,030) (1,961) (2,109) (4,136)
Net income (900) (3,149) (3,045) (2,941) (3,163) (6,204)

Cash Flow
Statement
Net income (900) (3,149) (3,045) (2,941) (3,163) (6,204)

CCA - 2,249 1,574 1,102 771 540
Investment &
Salvage (7,000) -
Disposal tax effect (199) 504
Net cash flow (8,099) (900) (1,470) (1,839) (2,391) (5,160)
PE(MARR) = $ (15,135)
AE(MARR) = $ (4,515)

11-26
11.24
(a) Opportunity cost = 23,058
(b)

Current Age= 10 MARR= 12%
UCC= 5,145 N= 2
dE= 30%
Year 0 1 2
Income Statement
Revenues - -
Expenses
O&M 30,000 30,000
Overhaul
CCA @dE 1,544 1,080
Taxable income (31,544) (31,080)
Income taxes @ t (12,617) (12,432)
Net income (18,926) (18,648)

Cash Flow Statement
Net income (18,926) (18,648)

CCA 1,544 1,080
Disposal tax effect 11,942 (3,792)
Net cash flow (23,058) (17,383) (9,359)
PE(MARR) = $ (46,039)
AE(MARR) = $ (27,241)

11-27
(c)
t= 40%
MARR= 12%
N= 8
dE= 30%
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenues - - - - - - - -
Expenses
O&M - - - - - - - -
CCA @dE 26,250 44,625 31,238 21,866 15,306 10,714 7,500 5,250
Taxable income (26,250) (44,625) (31,238) (21,866) (15,306) (10,714) (7,500) (5,250)
Income taxes @ t (10,500) (17,850) (12,495) (8,747) (6,123) (4,286) (3,000) (2,100)
Net income (15,750) (26,775) (18,743) (13,120) (9,184) (6,429) (4,500) (3,150)
Cash Flow Statement
Net income (15,750) (26,775) (18,743) (13,120) (9,184) (6,429) (4,500) (3,150)
CCA 26,250 44,625 31,238 21,866 15,306 10,714 7,500 5,250
Disposal tax effect 2,900
Net cash flow (175,000) 10,500 17,850 12,495 8,747 6,123 4,286 3,000 10,000
PE(MARR) = $ (125,901)
AE(MARR) = $ (25,344)
(d) The defender's AE value is -$27,241 while the challenger's AE value is -

$25,344.
The defender should be replaced by the challenger now.

11-28
11.25
(a) Initial cash outlay for the new machine = $130,000
(b)
Defender

UCC= 41,650 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M - - - - -
Overhaul
CCA @dE 12,495 8,747 6,123 4,286 3,000
Taxable income (12,495) (8,747) (6,123) (4,286) (3,000)
Income taxes @ t (4,998) (3,499) (2,449) (1,714) (1,200)
Net income (7,497) (5,248) (3,674) (2,571) (1,800)

Cash Flow Statement
Net income (7,497) (5,248) (3,674) (2,571) (1,800)

CCA 12,495 8,747 6,123 4,286 3,000
Investment &
Salvage (10,000) -
Disposal tax effect (12,660) 2,800
Net cash flow (22,660) 4,998 3,499 2,449 1,714 4,000
PE(MARR) = $ (11,089)
AE(MARR) = $ (3,308)

11-29
Challenger:
t= 40%
MARR= 15%
N= 7
dE= 30%
Year 0 1 2 3 4 5 6 7
Income Statement
Revenues 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Expenses
O&M - - - - - - -
CCA @dE 19,500 33,150 23,205 16,244 11,370 7,959 5,572
Taxable income 30,500 16,850 26,795 33,757 38,630 42,041 44,428
Income taxes @ t 12,200 6,740 10,718 13,503 15,452 16,816 17,771
Net income 18,300 10,110 16,077 20,254 23,178 25,224 26,657
Cash Flow Statement
Net income 18,300 10,110 16,077 20,254 23,178 25,224 26,657
CCA 19,500 33,150 23,205 16,244 11,370 7,959 5,572
Disposal tax effect (6,800)
Net cash flow (130,000) 37,800 43,260 39,282 36,497 34,548 33,184 55,429
PE(MARR) = $ 34,637
AE(MARR) = $ 8,325
The defender has an AE value of -$3,308, while the challenger has a positive AE value of
$8,325. The defender should be replaced by the challenger now.

11-30
11.26 (a) Defender:

UCC= 28,800 N= 5
dE= 20%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 30,000 30,000 30,000 30,000 30,000

Overhaul
CCA @dE 5,760 4,608 3,686 2,949 2,359
Taxable income (35,760) (34,608) (33,686) (32,949) (32,359)
Income taxes @ t (12,516) (12,113) (11,790) (11,532) (11,326)
Net income (23,244) (22,495) (21,896) (21,417) (21,034)

Cash Flow
Statement
Net income (23,244) (22,495) (21,896) (21,417) (21,034)

CCA 5,760 4,608 3,686 2,949 2,359
Investment &
Salvage (10,000) 5,000
Net cash flow (16,580) (17,484) (17,887) (18,210) (18,468) (12,121)
PE(MARR) = $ (73,867)
AE(MARR) = $ (22,036)

11-31
(b) Challenger:
t= 35%
MARR= 15%
N= 5
dE= 20%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M - - - - -
CCA @dE 8,500 15,300 12,240 9,792 7,834
Taxable income (8,500) (15,300) (12,240) (9,792) (7,834)
Income taxes @ t (2,975) (5,355) (4,284) (3,427) (2,742)
Net income (5,525) (9,945) (7,956) (6,365) (5,092)

Cash Flow Statement
Net income (5,525) (9,945) (7,956) (6,365) (5,092)
CCA 8,500 15,300 12,240 9,792 7,834

Investment & Salvage (85,000) -
Net cash flow (85,000) 2,975 5,355 4,284 3,427 13,709
PE(MARR) = $ (66,772)
AE(MARR) = $ (19,919)
(c)
The company should replace the defender because the challenger has a less negative AE
value.

11-32
11.27 (a) Defender:

UCC= 14,578 N= 3
dE= 30%
Year 0 1 2 3
Income Statement
Revenues 57,000 57,000 57,000
Expenses
O&M 36,000 36,000 36,000
Overhaul
CCA @dE 4,373 3,061 2,143
Taxable income 16,627 17,939 18,857
Income taxes @ t 6,651 7,175 7,543
Net income 9,976 10,763 11,314
Cash Flow Statement
Net income 9,976 10,763 11,314
CCA 4,373 3,061 2,143
Net cash flow (9,731) 14,349 13,825 16,177
PE(MARR) = $ 25,616
AE(MARR) = $ 10,665

11-33
(b) Challenger:
t= 40%
MARR= 12%
N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues 57,000 57,000 57,000 57,000 57,000
Expenses
O&M 33,000 33,000 33,000 33,000 33,000
CCA @dE 5,325 9,053 6,337 4,436 3,105
Taxable income 18,675 14,948 17,663 19,564 20,895
Income taxes @ t 7,470 5,979 7,065 7,826 8,358
Net income 11,205 8,969 10,598 11,739 12,537
Cash Flow Statement
Net income 11,205 8,969 10,598 11,739 12,537
CCA 5,325 9,053 6,337 4,436 3,105
Disposal tax effect 378
Net cash flow (35,500) 16,530 18,021 16,935 16,174 22,320
PE(MARR) = $ 28,623
AE(MARR) = $ 7,940
(c)
The defender has an AE value of $10,665 while the challenger has an AE value of
$7,940. Keep the defender for now.

11-34
Economic Service Life

11.28 (a) Defender:
Tax
Initial Price= $25,000 rate= 35%
Current age= 4 MARR= 12%
CCA Rate= 30%
Current UCC: $7,289
Holding Market Undeprec A/T PE of O&M A/T PE of Cum. Capital Cum. Total Total
Period Value Capital Market Market Cost O&M O&M PE of Cost PE of PE AE
N Cost Value Value Cost Cost O&M Allowance CCA Cost Cost
Cost Credit
0 $7,900 $7,289 $7,686 $7,686 $0 $0 $0 $0
1 4,300 5,102 4,581 4,090 3,200 2,080 1,857 1,857 $2,187 $683 $4,770 $5,342
2 3,300 3,571 3,395 2,706 3,700 2,405 1,917 3,774 1,531 1,110 7,644 4,523
3 1,100 2,500 1,590 1,132 4,800 3,120 2,221 5,995 1,071 1,377 11,172 4,652
4 0 1,750 613 389 5,850 3,803 2,417 8,412 750 1,544 14,164 4,663
The remaining economic life of the defender is two years with AEC = $4,523.
The cost of keeping the defender for the third year is: $4,957 = NSV_2(1+12%) NSV_3 t*CCA_3 +OC_3(1t)

11-35
(b) Challenger:
t= 35%
MARR= 12%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
CCA @dE 4,800 8,160 5,712 3,998 2,799 1,959 1,371 960 672 470
Taxable income (5,800) (9,160) (6,712) (4,998) (3,799) (2,959) (2,371) (1,960) (1,672) (1,470)
Income taxes @ t (2,030) (3,206) (2,349) (1,749) (1,330) (1,036) (830) (686) (585) (515)
Net income (3,770) (5,954) (4,363) (3,249) (2,469) (1,923) (1,541) (1,274) (1,087) (956)
Cash Flow Statement
Net income (3,770) (5,954) (4,363) (3,249) (2,469) (1,923) (1,541) (1,274) (1,087) (956)
CCA 4,800 8,160 5,712 3,998 2,799 1,959 1,371 960 672 470
Disposal tax effect (491)
Net cash flow (32,000) 1,030 2,206 1,349 749 330 36 (170) (314) (415) 1,524
$
PE(MARR) = (27,543)
AE(MARR) = $ (4,875)
The AEC of the defender is $4,523, which is smaller than the AEC of the challenger of $4,875. Don't replace the defender now.

11-36
(c) The defender will be kept for at least two years. Now consider keeping it for the third year.
As shown in (a), C3 = $4,957, which is larger than the AEC of the challenger.
The defender should be replaced at the end of year 2.

11-37
*
11.29 (a)
Tax
CCA Rate= 40%
Holding Undeprec A/T PV of A/T PV of Cum. PV Capital Cum. PV

Period Market Capital Market Market O&M O&M O&M of O&M Cost of CCA Total PV Total AE
N Value Cost Value Value Cost Cost Cost Cost Allowance Credit Cost Cost
0 10,000 10000 $ 10,000 $ 10,000 0$ - $ - $ -
1 5,300 8000 $ 6,380 $ 5,548 1500 $ 900 $ 783 $ 783 2000 $ 696 $ 4,539 $5,220
2 3,900 4800 $ 4,260 $ 3,221 2100 $ 1,260 $ 953 $ 1,735 3200 $ 1,664 $ 6,851 $4,214
3 2,800 2880 $ 2,832 $ 1,862 2900 $ 1,740 $ 1,144 $ 2,879 1920 $ 2,168 $ 8,849 $3,876
4 1,800 1728 $ 1,771 $ 1,013 3800 $ 2,280 $ 1,304 $ 4,183 1152 $ 2,432 $ 10,738 $3,761
5 1,400 1037 $ 1,255 $ 624 4800 $ 2,880 $ 1,432 $ 5,615 691 $ 2,569 $ 12,422 $3,706*
6 600 622 $ 609 $ 263 5900 $ 3,540 $ 1,530 $ 7,145 415 $ 2,641 $ 14,241 $3,763
The economic life is five years with AEC = $3,706.

11-38
*
(b)
Tax
CCA Rate= 40%
Undeprec A/T PV of A/T PV of Cum. PV Capital Cum. PV

Holding Market Capital Market Market O&M O&M O&M of O&M Cost of CCA Total PV Total AE
Period N Value Cost Value Value Cost Cost Cost Cost Allowance Credit Cost Cost
0 10,000 10,000 $ 10,000 $ 10,000 0$ - $ - $ -
1 5,300 8,000 $ 6,380 $ 6,076 1,500 $ 900 $ 857 $ 857 2,000 $ 762 $ 4,019 $4,220
2 3,900 4,800 $ 4,260 $ 3,864 2,100 $ 1,260 $ 1,143 $ 2,000 3,200 $ 1,923 $ 6,213 $3,341
3 2,800 2,880 $ 2,832 $ 2,446 2,900 $ 1,740 $ 1,503 $ 3,503 1,920 $ 2,586 $ 8,470 $3,110
4 1,800 1,728 $ 1,771 $ 1,457 3,800 $ 2,280 $ 1,876 $ 5,379 1,152 $ 2,965 $ 10,956 $3,090*
5 1,400 1,037 $ 1,255 $ 983 4,800 $ 2,880 $ 2,257 $ 7,635 691 $ 3,182 $ 13,470 $3,111
6 600 622 $ 609 $ 454 5,900 $ 3,540 $ 2,642 $ 10,277 415 $ 3,306 $ 16,517 $3,254
The economic life is four years with AEC = $3,090.

11-39
11.30 (a)
Tax
CCA Rate=
Holding Undeprec A/T PE of A/T PE of Cum. PE Capital Cum. PE Total Total

Period Market Capital Market Market O&M O&M O&M of O&M Cost of CCA PE AE
0 $20,000 $20,000 $20,000 $20,000 $0 $0 $0 $0
1 10,000 17,500 13,000 11,818 3,000 1,800 1,636 1,636 $2,500 $909 $8,909 $9,800
2 8,000 15,000 10,800 8,926 5,000 3,000 2,479 4,116 $2,500 1,736 13,455 7,752
3 6,000 12,500 8,600 6,461 7,000 4,200 3,156 7,271 $2,500 2,487 18,323 7,368*
4 4,000 10,000 6,400 4,371 9,000 5,400 3,688 10,959 $2,500 3,170 23,418 7,388
5 2,000 7,500 4,200 2,608 11,000 6,600 4,098 15,058 $2,500 3,791 28,659 7,560
6 0 5,000 2,000 1,129 13,000 7,800 4,403 19,460 $2,500 4,355 33,976 7,801
The economic life is three years with AEC = $7,368.

11-40
(b)
Tax
CCA Rate=
Cum. Cum.
Undeprec A/T PE of A/T PE of PE of Capital PE of Total Total
Holding Market Capital Market Market O&M O&M O&M O&M Cost CCA PE AE
0 $20,000 $20,000 $20,000 $20,000 $0 $0 $0 $0
1 10,000 17,500 13,000 10,400 3,000 1,800 1,440 1,440 $2,500 $800 $10,240 $12,800
2 8,000 15,000 10,800 6,912 5,000 3,000 1,920 3,360 $2,500 1,440 15,008 10,422
3 6,000 12,500 8,600 4,403 7,000 4,200 2,150 5,510 $2,500 1,952 19,155 9,813
4 4,000 10,000 6,400 2,621 9,000 5,400 2,212 7,722 $2,500 2,362 22,739 9,629
5 2,000 7,500 4,200 1,376 11,000 6,600 2,163 9,885 $2,500 2,689 25,819 9,601*
6 0 5,000 2,000 524 13,000 7,800 2,045 11,930 $2,500 2,951 28,454 9,641
The economic life is six years with AEC = $9,601.

11-41
(c)
Tax
Initial Price= 20,000 rate= 40%
CCA Rate=
Cum. Cum.
Holding Undeprec A/T PE of A/T PE of PE of Capital PE of Total Total
Period Market Capital Market Market O&M O&M O&M O&M Cost CCA PE AE
0 20000 20000 20000 20000 0 0 0 0
1 10000 17500 13000 13000 3000 1800 1800 1800 2500 1000 7800 7800
2 8000 15000 10800 10800 5000 3000 3000 4800 2500 2000 12000 6000
3 6000 12500 8600 8600 7000 4200 4200 9000 2500 3000 17400 5800*
4 4000 10000 6400 6400 9000 5400 5400 14400 2500 4000 24000 6000
5 2000 7500 4200 4200 11000 6600 6600 21000 2500 5000 31800 6360
6 0 5000 2000 2000 13000 7800 7800 28800 2500 6000 40800 6800
The economic life is three years with AEC = $5,800.

11-42
*
11.31 (a)
Tax
CCA Rate= 15%
Holding Undeprec A/T PE of A/T PE of Cum. PE Capital Cum. PE

Period Market Capital Market Market O&M O&M O&M of O&M Cost of CCA Total Total
N Value Cost Value Value Cost Cost Cost Cost Allowance Credit PE Cost AE Cost
0 $18,000 $18,000 $18,000 $18,000 $0 $0 $0 $0
1 14,400 16,650 15,300 13,909 2,500 1,500 1,364 1,364 $1,350 $491 $4,964 $5,460
2 11,520 14,153 12,573 10,391 3,250 1,950 1,612 2,975 2,498 1,317 9,268 5,340
3 9,216 12,030 10,341 7,770 4,225 2,535 1,905 4,880 2,123 1,955 13,156 5,290*
4 7,373 10,225 8,514 5,815 5,493 3,296 2,251 7,131 1,804 2,447 16,868 5,321
5 5,898 8,691 7,015 4,356 7,140 4,284 2,660 9,791 1,534 2,828 20,606 5,436
The economic life is three years with AEC of $5,290.

11-43
*
(b)
Tax
CCA Rate= 15%
Cum.
Undeprec A/T PE of A/T PE of Cum. PE Capital PE of Total Total
Holding Market Capital Market Market O&M O&M O&M of O&M Cost CCA PE AE
0 $18,000 $18,000 $18,000 $18,000 $0 $0 $0 $0
1 14,400 16,650 15,300 12,750 2,500 1,500 1,250 1,250 $1,350 $450$6,050$7,260
2 11,520 14,153 12,573 8,731 3,250 1,950 1,354 2,604 2,498 1,14410,729 7,023
3 9,216 12,030 10,341 5,985 4,225 2,535 1,467 4,071 2,123 1,63514,451 6,860
4 7,373 10,225 8,514 4,106 5,493 3,296 1,589 5,661 1,804 1,98317,5726,788*
5 5,898 8,691 7,015 2,819 7,140 4,284 1,722 7,382 1,534 2,23020,333 6,799
The economic life is four years with AEC of $6,788.

11-44
11.32 (a)
Defender:

UCC= 13,000 N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M - - - - - - - - -
Overhaul
CCA @dE 3,900 2,730 1,911 1,338 936 655 459 321 225 157
Taxable income (3,900) (2,730) (1,911) (1,338) (936) (655) (459) (321) (225) (157)
Income taxes @ t (1,560) (1,092) (764) (535) (375) (262) (184) (128) (90) (63)
Net income (2,340) (1,638) (1,147) (803) (562) (393) (275) (193) (135) (94)
Cash Flow Statement
Net income (2,340) (1,638) (1,147) (803) (562) (393) (275) (193) (135) (94)
CCA 3,900 2,730 1,911 1,338 936 655 459 321 225 157
Investment & Salvage - -
Disposal tax effect (5,200) 147
Net cash flow (5,200) 1,560 1,092 764 535 375 262 184 128 90 210
PE(MARR) = $ (1,286)
AE(MARR) = $ (209)
Defender has an AEC of $209.

11-45
Challenger:
t= 40%
MARR= 10%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,00030,000
Expenses
O&M - - - - - - - - - -
CCA @dE 24,000 40,800 28,560 19,992 13,994 9,796 6,857 4,800 3,3602,352
Taxable income 6,000 (10,800) 1,440 10,008 16,006 20,204 23,143 25,200 26,64027,648
Income taxes @ t 2,400 (4,320) 576 4,003 6,402 8,082 9,257 10,080 10,65611,059
Net income 3,600 (6,480) 864 6,005 9,603 12,122 13,886 15,120 15,98416,589
Cash Flow Statement
Net income 3,600 (6,480) 864 6,005 9,603 12,122 13,886 15,120 15,98416,589
CCA 24,000 40,800 28,560 19,992 13,994 9,796 6,857 4,800 3,3602,352
Net cash flow (160,000) 27,600 34,320 29,424 25,997 23,598 21,918 20,743 19,920 19,34421,136
PE(MARR) = $ (3,368)
AE(MARR) = $ (548)
Challenger has an AEC of $548, which is larger than that of the defender. Don`t replace the defender now.

11-46
(b)
Defender:
UCC= 13,000 N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M - - - - - - - - -
Overhaul
CCA @dE 3,900 2,730 1,911 1,338 936 655 459 321 225 157
Taxable income (3,900) (2,730) (1,911) (1,338) (936) (655) (459) (321) (225) (157)
Income taxes @ t (1,560) (1,092) (764) (535) (375) (262) (184) (128) (90) (63)
Net income (2,340) (1,638) (1,147) (803) (562) (393) (275) (193) (135) (94)
Cash Flow Statement
Net income (2,340) (1,638) (1,147) (803) (562) (393) (275) (193) (135) (94)
CCA 3,900 2,730 1,911 1,338 936 655 459 321 225 157
Disposal tax effect 12,800 147
Net cash flow (32,200) 1,560 1,092 764 535 375 262 184 128 90 210
$
PE(MARR) = (28,286)
AE(MARR) = $ (4,603)
Defender has an AEC value of $4,603, much higher than that of the challenger of $548. Replace the defender now.

11-47
(c)
Challenger:
t= 40%
MARR= 10%
N= 12
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10 11 12
Income Statement
Revenues 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
Expenses
O&M - - - - - - - - - - - -
CCA @dE 24,000 40,800 28,560 19,992 13,994 9,796 6,857 4,800 3,360 2,352 1,646 1,152
Taxable income (9,000) (25,800) (13,560) (4,992) 1,006 5,204 8,143 10,200 11,640 12,648 13,354 13,848
Income taxes @ t (3,600) (10,320) (5,424) (1,997) 402 2,082 3,257 4,080 4,656 5,059 5,341 5,539
Net income (5,400) (15,480) (8,136) (2,995) 603 3,122 4,886 6,120 6,984 7,589 8,012 8,309
Cash Flow Statement
Net income (5,400) (15,480) (8,136) (2,995) 603 3,122 4,886 6,120 6,984 7,589 8,012 8,309
CCA 24,000 40,800 28,560 19,992 13,994 9,796 6,857 4,800 3,360 2,352 1,646 1,152
Net cash flow (160,000) 18,600 25,320 20,424 16,997 14,598 12,918 11,743 10,920 10,344 9,941 9,659 10,537
PE(MARR) = $ (52,773)
AE(MARR) = $ (7,745)
The challenger has an AEC value of $7,745, higher than that of the defender of $4,603 in (b). Dont replace the defender now.

11-48
11.33 (a)
Defender Model A:
UCC= 95,200 N= 8
dE= 30%
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenues - - - - - - - -
Expenses
O&M - - - - - - -
Overhaul
CCA @dE 28,560 19,992 13,994 9,796 6,857 4,800 3,360 2,352
Taxable income (28,560) (19,992) (13,994) (9,796) (6,857) (4,800) (3,360) (2,352)
Income taxes @ t (11,424) (7,997) (5,598) (3,918) (2,743) (1,920) (1,344) (941)
Net income (17,136) (11,995) (8,397) (5,878) (4,114) (2,880) (2,016) (1,411)
Cash Flow Statement
Net income (17,136) (11,995) (8,397) (5,878) (4,114) (2,880) (2,016) (1,411)
CCA 28,560 19,992 13,994 9,796 6,857 4,800 3,360 2,352
Net cash flow (38,080) 11,424 7,997 5,598 3,918 2,743 1,920 1,344 3,136
PE(MARR) = $ (9,264)
AE(MARR) = $ (1,736)

11-49
Challenger Model B:
t= 40%
MARR= 10%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues 75,000 75,000 75,000 75,000 75,000 75,000 75,000 75,000 75,000 75,000
Expenses
O&M - - - - - - - - - -
CCA @dE 60,000 102,000 71,400 49,980 34,986 24,490 17,143 12,000 8,400 5,880
Taxable income 15,000 (27,000) 3,600 25,020 40,014 50,510 57,857 63,000 66,600 69,120
Income taxes @ t 6,000 (10,800) 1,440 10,008 16,006 20,204 23,143 25,200 26,640 27,648
Net income 9,000 (16,200) 2,160 15,012 24,008 30,306 34,714 37,800 39,960 41,472
Cash Flow Statement
Net income 9,000 (16,200) 2,160 15,012 24,008 30,306 34,714 37,800 39,960 41,472
CCA 60,000 102,000 71,400 49,980 34,986 24,490 17,143 12,000 8,400 5,880
Net cash flow (400,000) 69,000 85,800 73,560 64,992 58,994 54,796 51,857 49,800 48,360 52,840
PE(MARR) = $ (8,420)
AE(MARR) = $ (1,370)
Model A (defender) has an AEC of $1,736 while Model B (challenger) has an AEC of $1,370. Replace the defender now.
(b) It is rather difficult to predict what technological advances would be made on typical equipment in the future. If the
industrial engineer had expected a more efficient lathe to be available in one or two years, he could defer the replacement
decision. Since Model A was already placed in service, the amount of $150,000 expended is a sunk cost, and it should not
be considered in future replacement decisions.

11-50
*
11.34 Defender:

UCC= 6,123 N= 6
dE= 30%
Year 0 1 2 3 4 5 6
Income Statement
Revenues - - - - - -
Expenses
O&M 2,000 2,000 2,000 2,000 2,000 2,000
Overhaul
CCA @dE 1,837 1,286 900 630 441 309
Taxable income (3,837) (3,286) (2,900) (2,630) (2,441) (2,309)
Income taxes @ t (1,151) (986) (870) (789) (732) (693)
Net income (2,686) (2,300) (2,030) (1,841) (1,709) (1,616)
Cash Flow Statement
Net income (2,686) (2,300) (2,030) (1,841) (1,709) (1,616)
CCA 1,837 1,286 900 630 441 309
Disposal tax effect (37) (234)
Net cash flow (6,037) (849) (1,014) (1,130) (1,211) (1,268) (41)
PE(MARR) = $ (10,368)
AE(MARR) = $ (2,243)

11-51
*
Challenger:
t= 30%
MARR= 8%
N= 12
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10 11 12
Income Statement
Revenues - - - - - - - - - - - -
Expenses
O&M 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
CCA @dE 3,450 5,865 4,106 2,874 2,012 1,408 986 690 483 338 237 166
Taxable income (4,450) (6,865) (5,106) (3,874) 3,012) (2,408) (1,986) (1,690) (1,483) 1,338) (1,237) (1,166)
Income taxes @ t (1,335) (2,060) (1,532) (1,162) (904) (722) (596) (507) (445) (401) (371) (350)
Net income (3,115) (4,806) (3,574) (2,712) (2,108) (1,686) (1,390) (1,183) (1,038) (937) (866) (816)
Cash Flow Statement
Net income (3,115)(4,806) (3,574) (2,712) (2,108) (1,686) (1,390) (1,183) (1,038) (937) (866) (816)
CCA 3,450 5,865 4,106 2,874 2,012 1,408 986 690 483 338 237 166
Investment & Salvage (23,000) 500
Net cash flow (23,000) 335 1,060 532 162 (96) (278) (404) (493) (555) (599) (629) (184)
PE(MARR) = $ (22,881)
AE(MARR) = $ (3,036)
Challenger`s AEC of $3,036 is larger than that of the defender, $2,243. Dont replace the defender now.

11-52
11.35 (a) Defender:

UCC= 2,215 N= 3
dE= 25%
Year 0 1 2 3
Income Statement
Revenues - - -
Expenses
O&M 3,000 4,500 6,000
Overhaul
CCA @dE 554 415 311
Taxable income (3,554) (4,915) (6,311)
Income taxes @ t (1,421) (1,966) (2,525)
Net income (2,132) (2,949) (3,787)
Cash Flow Statement
Net income (2,132) (2,949) (3,787)
CCA 554 415 311
Disposal tax effect 714 (26)
Net cash flow (3,286) (1,579) (2,534) (2,502)
PE(MARR) = $ (8,219)
AE(MARR) = $ (3,600)

11-53
(b) Challenger:
t= 40%
MARR= 15%
N= 3
dE= 25%
Year 0 1 2 3
Income Statement
Revenues - - -
Expenses
O&M 2,000 3,000 4,000
CCA @dE 875 1,531 1,148
Taxable income (2,875) (4,531) (5,148)
Income taxes @ t (1,150) (1,813) (2,059)
Net income (1,725) (2,719) (3,089)
Cash Flow Statement
Net income (1,725) (2,719) (3,089)
CCA 875 1,531 1,148
Net cash flow (7,000) (850) (1,188) 638
PE(MARR) = $ (8,218)
AE(MARR) = $ (3,599)
Defenders AEC of $3,600 is larger than that of the challenger of $3,599. Replace the
defender now. Actually, there is hardly any difference between the two AEC values. It
does not make much economic difference whether the defender is replaced right now.

11-54
11.36 (a): Opportunity cost = $2,000 as calculated in (b) under disposal tax effect
(b)
Defender:
Original Price= t= 40%

Current Age= MARR= 10%
UCC= 5,000 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 3,000 3,000 3,000 3,000 3,000

Overhaul
CCA @dE 1,500 1,050 735 515 360
Taxable income (4,500) (4,050) (3,735) (3,515) (3,360)
Income taxes @ t (1,800) (1,620) (1,494) (1,406) (1,344)
Net income (2,700) (2,430) (2,241) (2,109) (2,016)

Cash Flow Statement
Net income (2,700) (2,430) (2,241) (2,109) 2,016)
CCA 1,500 1,050 735 515 360

Disposal tax effect (2,000) 336
Net cash flow (2,000) (1,200) (1,380) (1,506) (1,594) (1,320)
PE(MARR) = $ (7,271)
AE(MARR) = $ (1,918)

11-55
Challenger:
t= 40%
MARR= 10%
N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M - - - - -
CCA @dE 1,650 2,805 1,964 1,374 962
Taxable income (1,650) (2,805) (1,964) (1,374) (962)
Income taxes @ t (660) (1,122) (785) (550) (385)
Net income (990) (1,683) (1,178) (825) (577)
Cash Flow Statement
Net income (990) (1,683) (1,178) (825) (577)
CCA 1,650 2,805 1,964 1,374 962
Net cash flow (11,000) 660 1,122 785 550 1,283
PE(MARR) = $ (7,711)
AE(MARR) = $ (2,034)
The defender`s AEC is $1,918, smaller than the challenger`s AEC of $2,034. Dont
replace the defender now.
(c) Incremental cash flows
Year: 0 1 2 3 4 5
Net cash flows: -9000 1860 2502 2291 2144 2603
IRR= 8.14%
The incremental IRR is lower than MARR of 10%. Reject the challenger.

11-56
*
11.37 (a)
Defender:

UCC= 1,100 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues 10,000 10,000 10,000 10,000 10,000
Expenses
O&M 7,000 7,000 7,000 7,000 7,000
Overhaul
CCA @dE 330 231 162 113 79
Taxable income 2,670 2,769 2,838 2,887 2,921
Income taxes @ t 1,068 1,108 1,135 1,155 1,168
Net income 1,602 1,661 1,703 1,732 1,752
Cash Flow Statement
Net income 1,602 1,661 1,703 1,732 1,752
CCA 330 231 162 113 79
Disposal tax effect 360 74
Net cash flow (1,640) 1,932 1,892 1,865 1,845 1,906
PE(MARR) = $ 4,699
AE(MARR) = $ 1,402

11-57
*
Challenger:
t= 40%
MARR= 15%
N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues 11,500 11,500 11,500 11,500 11,500
Expenses
O&M 5,000 5,000 5,000 5,000 5,000
CCA @dE 2,250 3,825 2,678 1,874 1,312
Taxable income 4,250 2,675 3,823 4,626 5,188
Income taxes @ t 1,700 1,070 1,529 1,850 2,075
Net income 2,550 1,605 2,294 2,775 3,113
Cash Flow Statement
Net income 2,550 1,605 2,294 2,775 3,113
CCA 2,250 3,825 2,678 1,874 1,312
Net cash flow (15,000) 4,800 5,430 4,971 4,650 6,849
PE(MARR) = $ 2,612
AE(MARR) = $ 779
The defenders AE value is $1,402, which is larger than the challenger's AE value of
$779. Keep the defender for now.
(b) Using Goal Seek on the spreadsheet of the defender, we find that when the
current market value of the defender is $5,480, the two options are equivalent.

11-58
11.38 Challenger:
t= 40%
MARR= 14%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - -
Expenses
O&M 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000
CCA @dE 33,000 56,100 39,270 27,489 19,242 13,470 9,429 6,600 4,620 3,234
Taxable income 38,000) (61,100) (4,270) (32,489) (24,242) (18,470) (14,429) (11,600) (9,620) (8,234)
Income taxes @ t (15,200) (24,440) (17,708) (12,996) (9,697) (7,388) (5,771) (4,640) (3,848) (3,294)
Net income (22,800) (36,660) (26,562) (19,493) (14,545) (11,082) (8,657) (6,960) (5,772) (4,940)
Cash Flow Statement
Net income (22,800) (36,660) (26,562) (19,493) (14,545) (11,082) (8,657) (6,960) (5,772) (4,940)
CCA 33,000 56,100 39,270 27,489 19,242 13,470 9,429 6,600 4,620 3,234
Net cash flow (220,000) 10,200 19,440 12,708 7,996 4,697 2,388 771 (360) 1,152) 12,112
PE(MARR) = $ (176,160)
AE(MARR) = $ (33,772)

11-59
Defender:

UCC= 3,430 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - -
Expenses
O&M 20,000 20,000 20,000 20,000 20,000
Overhaul
CCA @dE 1,029 720 504 353 247
Taxable income (21,029) (20,720) (20,504) (20,353) (20,247)
Income taxes @ t (8,412) (8,288) (8,202) (8,141) (8,099)
Net income (12,617) (12,432) (12,303) (12,212) (12,148)
Cash Flow Statement
Net income (12,617) (12,432) (12,303) (12,212) (12,148)
CCA 1,029 720 504 353 247
Net cash flow (75,719) (11,588) (11,712) (11,798) (11,859) (11,671)
PE(MARR) = $ (115,942)
AE(MARR) = $ (33,772)
If the current resale value of the defender is $123,911, the two options are equivalent.
This would not be possible as the defender was bought 10 years ago for only $100,000.
Thus, the defender is much better than the challenger.

11-60
11.39 (a)
Find the economic life of the defender
Tax
CCA Rate= 30%
Current UCC: $7,143
Holding Period Market Undeprec A/T PE of O&M A/T PE of Cum. PE Capital Cum. PE Total PE Total AE
N Value Capital Market Market Cost O&M O&M of O&M Cost of CCA Cost Cost
Cost Value Value Cost Cost Cost Allowance Credit
0 $8,000 $7,143 $7,700 $7,700 $0 $0 $0 $0
1 5,200 5,000 5,130 4,347 6,000 3,900 3,305 3,305 $2,143 $636 $6,022 $7,106
2 3,500 3,500 3,500 2,514 7,000 4,550 3,268 6,573 1,500 1,013 10,747 6,864
3 1,200 2,450 1,638 997 10,000 6,500 3,956 10,529 1,050 1,236 15,996 7,357
The economic life of the defender is two years with AEC of $6,864.

11-61
(a)
Find the AEC of the challenger
t= 35%
MARR= 18%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500
CCA @dE 6,375 10,838 7,586 5,310 3,717 2,602 1,821 1,275 893 625
Taxable income (7,875) (12,338) (9,086) (6,810) (5,217) (4,102) (3,321) (2,775) (2,393) (2,125)
Income taxes @ t (2,756) (4,318) (3,180) (2,384) (1,826) (1,436) (1,163) (971) (837) (744)
Net income (5,119) (8,019) (5,906) (4,427) (3,391) (2,666) (2,159) (1,804) (1,555) (1,381)
Cash Flow Statement
Net income (5,119) (8,019) (5,906) (4,427) (3,391) (2,666) (2,159) (1,804) (1,555) (1,381)
CCA 6,375 10,838 7,586 5,310 3,717 2,602 1,821 1,275 893 625
Net cash flow (42,500) 1,256 2,818 1,680 884 326 (64) (337) (529) (663) 2,029
PE(MARR) = $ (37,823)
AE(MARR) = $ (8,416)
The AEC of the defender is $6,864, which is smaller than the AEC of the challenger of $8,416. Dont replace the defender now.

11-62
(b) For the third year of the defender
Year 2 3
A/T OC: 6,500
NMV: 3500 1638
t*CCA: 368
Net: -3500 -4,494
FV: -8624
The cost of keeping the defender for the third year is $8,624, higher than the AEC of the challenger.
Thus, the defender should not be kept for the third year; that is, it should be replaced at the end of year 2.

11-63
*
11.40 Defender:
UCC= 10,872 N= 10
dE= 20%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - -
Expenses
O&M 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000
Overhaul
CCA @dE 2,174 1,739 1,392 1,113 891 712 570 456 365 292
Taxable income (20,174) (19,739) (19,392) (19,113) (18,891) (18,712) 18,570) (18,456) (18,365) (18,292)
Income taxes @ t (8,070) (7,896) (7,757) (7,645) (7,556) (7,485) (7,428) (7,382) (7,346) (7,317)
Net income (12,105) (11,844) (11,635) (11,468) (11,334) (11,227) (11,142) (11,074) (11,019) (10,975)
Cash Flow Statement
Net income (12,105) (11,844) (11,635) 11,468) (11,334) 11,227) 11,142) 11,074) 11,019) 10,975)
CCA 2,174 1,739 1,392 1,113 891 712 570 456 365 292
Net cash flow 40,349) (9,930) 10,104) 10,243) 10,355) 10,444) 10,515) 10,572) 10,618) 10,654) 10,216)
PE(MARR) = $ (98,597)
AE(MARR) = $ (17,450)

11-64
*
Challenger:
t= 40%
MARR= 12%
N= 10
dE= 20%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000
CCA @dE 18,000 32,400 25,920 20,736 16,589 13,271 10,617 8,493 6,795 5,436
Taxable income 22,000) 36,400) 29,920) 24,736) 20,589) 17,271) 14,617) 12,493) 10,795) 9,436)
Income taxes @ t (8,800) 14,560) 11,968) (9,894) (8,236) (6,908) 5,847) 4,997) 4,318) 3,774)
Net income 13,200) 21,840) 17,952) 14,842) 12,353) 10,363) 8,770) 7,496) 6,477) 5,661)
Cash Flow Statement
Net income 13,200) 21,840) 17,952) 14,842) 12,353) 10,363) (8,770) (7,496) (6,477) 5,661)
CCA 18,000 32,400 25,920 20,736 16,589 13,271 10,617 8,493 6,795 5,436
Net cash flow (180,000) 4,800 10,560 7,968 5,894 4,236 2,908 1,847 997 318 20,472
PE(MARR) = $ (146,057)
AE(MARR) = $ (25,850)
The AEC of the defender is $17,450, lower than the AEC of the challenger $25,850.
Keep the defender for now.

11-65
11.41 Defender:

UCC= 3850 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - -
Expenses
O&M 8,700 8,700 8,700 8,700 8,700
Overhaul
CCA @dE 1,155 809 566 396 277
Taxable income (9,855) (9,509) (9,266) (9,096) (8,977)
Income taxes @ t (3,449) (3,328) (3,243) (3,184) (3,142)
Net income (6,406) (6,181) (6,023) (5,913) (5,835)
Cash Flow Statement
Net income (6,406) (6,181) (6,023) (5,913) (5,835)
CCA 1,155 809 566 396 277
Net cash flow (6,873) (5,251) (5,372) (5,457) (5,516) (5,331)
PE(MARR) = $(26,258)
AE(MARR) = $ (7,284)

11-66
Challenger:
t= 35%
MARR= 12%
N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 4,200 4,700 5,200 5,700 6,200
CCA @dE 7,800 13,260 9,282 6,497 4,548
Taxable income (12,000) (17,960) (14,482) (12,197) (10,748)
Income taxes @ t (4,200) (6,286) (5,069) (4,269) (3,762)
Net income (7,800) (11,674) (9,413) (7,928) (6,986)
Cash Flow Statement
Net income (7,800) (11,674) (9,413) (7,928) (6,986)
CCA 7,800 13,260 9,282 6,497 4,548
Net cash flow (52,000) - 1,586 (131) (1,431) 9,076
PE(MARR) = $ (46,588)
AE(MARR) = $ (12,924)
The AEC of the defender is $7,284. The AEC of the challenger is $12,924.
The defender has a lower AEC value. Keep the defender for now.

11-67
11.42
Tax
CCA Rate= 30%
Current UCC: $6,997
Undeprec A/T PE of A/T PE of Cum. PE Capital Cum. PE

Holding Market Capital Market Market O&M O&M O&M of O&M Cost of CCA Total PE Total AE
0 $2,000 $6,997 $3,999 $3,999 $0 $0 $0 $0
1 1,500 4,898 2,859 2,599 3,800 2,280 2,073 2,073 $2,099 $763 $2,709 $2,980
2 1,200 3,429 2,091 1,728 3,800 2,280 1,884 3,957 1,469 1,249 4,978 2,868
3 960 2,400 1,536 1,154 3,800 2,280 1,713 5,670 1,029 1,558 6,957 2,797
4 768 1,680 1,133 774 3,800 2,280 1,557 7,227 720 1,755 8,698 2,744
5 614 1,176 839 521 3,800 2,280 1,416 8,643 504 1,880 10,241 2,701*
The economic life is five years with AEC of $2,701.

11-68
Find the AEC of the challenger
t= 40%
MARR= 10%
N= 12
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10 11 12
Income Statement
Revenues 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000 6,000
Expenses
O&M 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
CCA @dE 7,350 12,495 8,747 6,123 4,286 3,000 2,100 1,470 1,029 720 504 353
Taxable income (4,350) (9,495) (5,747) (3,123) (1,286) (0) 900 1,530 1,971 2,280 2,496 2,647
Income taxes @ t (1,740) (3,798) (2,299) (1,249) (514) (0) 360 612 788 912 998 1,059
Net income (2,610) (5,697) (3,448) (1,874) (771) (0) 540 918 1,183 1,368 1,497 1,588
Cash Flow Statement
Net income (2,610) (5,697) (3,448) (1,874) (771) (0) 540 918 1,183 1,368 1,497 1,588
CCA 7,350 12,495 8,747 6,123 4,286 3,000 2,100 1,470 1,029 720 504 353
Net cash flow (49,000) 4,740 6,798 5,299 4,249 3,514 3,000 2,640 2,388 2,212 2,088 2,002 4,071
PE(MARR) = $ (22,104)
AE(MARR) = $ (3,244)
Defender has an AEC of $2,701. Challenger has an AEC of $3,244. The defenders cost is lower. Keep the defender for now.

11-69
11.43 * Option 1:
Defender:

UCC= 4,000 N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
Overhaul
CCA @dE 1,200 840 588 412 288 202 141 99 69 48
Taxable income (16,200) (15,840) (15,588) (15,412) (15,288) (15,202) (15,141) (15,099) (15,069) (15,048)
Income taxes @ t (6,480) (6,336) (6,235) (6,165) (6,115) (6,081) (6,056) (6,040) (6,028) (6,019)
Net income (9,720) (9,504) (9,353) (9,247) (9,173) (9,121) (9,085) (9,059) (9,042) (9,029)
Cash Flow Statement
Net income (9,720) (9,504) (9,353) (9,247) (9,173) (9,121) (9,085) (9,059) (9,042) (9,029)
CCA 1,200 840 588 412 288 202 141 99 69 48
Disposal tax effect 800 45
Net cash flow (5,200) (8,520) (8,664) (8,765) (8,835) (8,885) (8,919) (8,944) (8,960) (8,972) (8,935)
PE(MARR) = $ (54,905)
AE(MARR) = $ (9,717)
*
Challenger:

11-70
t= 40%
MARR= 12%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000
CCA @dE 7,350 12,495 8,747 6,123 4,286 3,000 2,100 1,470 1,029 720
Taxable income (19,350) (24,495) (20,747) (18,123) (16,286) (15,000) (14,100) (13,470) (13,029) (12,720)
Income taxes @ t (7,740) (9,798) (8,299) (7,249) (6,514) (6,000) (5,640) (5,388) (5,212) (5,088)
Net income (11,610) (14,697) (12,448) (10,874) (9,771) (9,000) (8,460) (8,082) (7,817) (7,632)
Cash Flow Statement
Net income (11,610) (14,697) (12,448) (10,874) (9,771) (9,000) (8,460) (8,082) (7,817) (7,632)
CCA 7,350 12,495 8,747 6,123 4,286 3,000 2,100 1,470 1,029 720
Net cash flow (49,000) (4,260) (2,202) (3,701) (4,751) (5,486) (6,000) (6,360) (6,612) (6,788) (3,240)
PE(MARR) = $ (75,404)
AE(MARR) = $ (13,345)
*
Option 2:
Challenger:
t= 40%
MARR= 12%

11-71
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000
CCA @dE 12,750 21,675 15,173 10,621 7,435 5,204 3,643 2,550 1,785 1,250
Taxable income (36,750) (45,675) (39,173) (34,621) (31,435) (29,204) (27,643) (26,550) (25,785) (25,250)
Income taxes @ t (14,700) (18,270) (15,669) (13,848) (12,574) (11,682) (11,057) (10,620) (10,314) (10,100)
Net income (22,050) (27,405) (23,504) (20,772) (18,861) (17,523) (16,586) (15,930) (15,471) (15,150)
Cash Flow Statement
Net income (22,050) (27,405) (23,504) (20,772) (18,861) (17,523) (16,586) (15,930) (15,471) (15,150)
CCA 12,750 21,675 15,173 10,621 7,435 5,204 3,643 2,550 1,785 1,250
Net cash flow (85,000) (9,300) (5,730) (8,331) (10,152) (11,426) (12,318) (12,943) (13,380) (13,686) (7,334)
PE(MARR) = $ (141,533)
AE(MARR) = $ (25,049)
Option 1 has a combined AEC of $23,062; Option 2 has an AEC of $25,049.
Option 1 is cheaper and better.

11-72
11.44
Tax
CCA Rate= 30%
Current UCC: $1,286
Holding Market Undeprec A/T PE of O&M A/T PE of Cum. PE Capital Cum. PE Total PE Total AE
Period N Value Capital Market Market Cost O&M O&M of O&M Cost of CCA Cost Cost
Cost Value Value Cost Cost Cost Allowance Credit
0 $1,500 $1,286 $1,436 $1,436 $0 $0 $0 $0
1 1,200 900 1,110 991 1,900 1,330 1,188 1,188 $386 $103 $1,529 $1,712
2 1,000 630 889 709 2,300 1,610 1,283 2,471 270 168 3,030 1,793
3 500 441 482 343 2,700 1,890 1,345 3,816 189 208 4,700 1,957
4 0 309 93 59 3,100 2,170 1,379 5,195 132 233 6,339 2,087
5 0 216 65 37 3,400 2,380 1,350 6,546 93 249 7,695 2,135
The defender's economic life is one year with AEC = $1,712.

11-73
Challenger:
t= 30%
MARR= 12%
N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 1,100 1,300 1,500 1,700 1,800
CCA @dE 825 1,403 982 687 481
Taxable income (1,925) (2,703) (2,482) (2,387) (2,281)
Income taxes @ t (578) (811) (745) (716) (684)
Net income (1,348) (1,892) (1,737) (1,671) (1,597)
Cash Flow Statement
Net income (1,348) (1,892) (1,737) (1,671) (1,597)
CCA 825 1,403 982 687 481
Net cash flow (5,500) (523) (489) (755) (984) (79)
PE(MARR) = $ (7,564)
AE(MARR) = $ (2,098)
The defenders AEC is $1,712. The challenger's AEC is $2,098. The defender costs less.

11-74
11.45
Defender:

UCC= 9,844 N= 6
dE= 25%
Year 0 1 2 3 4 5 6
Income Statement
Revenues - - - - - -
Expenses
O&M 4,000 4,000 4,000 4,000 4,000 4,000
Overhaul
CCA @dE 2,461 1,846 1,384 1,038 779 584
Taxable income (6,461) (5,846) (5,384) (5,038) (4,779) (4,584)
Income taxes @ t (1,938) (1,754) (1,615) (1,511) (1,434) (1,375)
Net income (4,523) (4,092) (3,769) (3,527) (3,345) (3,209)
Cash Flow Statement
Net income (4,523) (4,092) (3,769) (3,527) (3,345) (3,209)
CCA 2,461 1,846 1,384 1,038 779 584
Disposal tax effect 647 (74)
Net cash flow (11,353) (2,062) (2,246) (2,385) (2,489) (2,566) (699)
PE(MARR) = $(20,313)
AE(MARR) = $ (4,802)
The defender's AEC is $4,802. Its PEC is $20,313 for six years.

11-75
Challenger :
t= 30%
MARR= 11%
N= 3
dE= 25%
Year 0 1 2 3
Income Statement
Revenues - - -
Expenses
O&M 2,000 2,000 2,000
CCA @dE 1,625 2,844 2,133
Taxable income (3,625) (4,844) (4,133)
Income taxes @ t (1,088) (1,453) (1,240)
Net income (2,538) (3,391) (2,893)
Cash Flow Statement
Net income (2,538) (3,391) (2,893)
CCA 1,625 2,844 2,133
Net cash flow (13,000) (913) (547) 3,959
PE(MARR) = $ (11,371)
AE(MARR) = $ (4,653)
The challenger's AEC is $4,653, smaller than the defender's AEC of $4,802.
Replace the defender now.
The challenger's PEC is $19,685 for six years, lower than the PEC of the defender, $20,313.
The challenger is better. Each challenger has a three-year life cycle. The total PEC of the
challenger over six years (two life cycles) is $11,371 (1 + (1+11%)-3) = $19,685.

11-76
ST11.1
Defender:

UCC= 125,000 N= 10
dE= S-L Methodwith N = 10 and S = 0
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 45,000 45,000 45,000 45,000 45,000 45,000 45,000 45,000 45,000 45,000
Overhaul
CCA-Present Facility 25,000 25,000 25,000 25,000 25,000 - - - - -
CCA-Upgrade Facility 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400
Taxable income (80,400) (80,400) (80,400) (80,400) (80,400) (55,400) (55,400) (55,400) (55,400) (55,400)
Income taxes @ t (24,120) (24,120) (24,120) (24,120) (24,120) (16,620) (16,620) (16,620) (16,620) (16,620)
Net income (56,280) (56,280) (56,280) (56,280) (56,280) (38,780) (38,780) (38,780) (38,780) (38,780)
Cash Flow Statement
Net income (56,280) (56,280) (56,280) (56,280) (56,280) (38,780) (38,780) (38,780) (38,780) (38,780)
CCA-Present Facility 25,000 25,000 25,000 25,000 25,000 - - - - -
CCA-Upgrade Facility 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400 10,400
Present Facility - -
Disposal tax effect (37,500) -
Upgrade Facility (104,000) -
Disposal tax effect -
Net cash flow (141,500) (20,880) (20,880) (20,880) (20,880) (20,880) (28,380) (28,380) (28,380) (28,380) (28,380)
PE(MARR) = $ (238,053)
AE(MARR) = $ (56,781)

11-77

11-78
ST11.1 (a)
Challenger:
t= 30%
MARR= 20%
N= 10
dE= S-L Method with S = 0 and N = 10
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues - - - - - - - - - -
Expenses
O&M 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000
CCA @dE 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500
Taxable income (42,500) (42,500) (42,500) (42,500) (42,500) (42,500) (42,500) (42,500) (42,500) (42,500)
Income taxes @ t (12,750) (12,750) (12,750) (12,750) (12,750) (12,750) (12,750) (12,750) (12,750) (12,750)
Net income (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750)
Cash Flow Statement
Net income (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750) (29,750)
CCA 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500 32,500
Disposal tax effect -
Net cash flow (325,000) 2,750 2,750 2,750 2,750 2,750 2,750 2,750 2,750 2,750 2,750
PE(MARR) = $ (313,471)
AE(MARR) = $ (74,770)
Defender's AEC is $56,781. Challenger's AEC is $74,770. Defender costs less.


11-79
(b) If environmental impact is taken into account, it might be better to install the new facility. It is also quite possible that
the government of Kazakhstan would impose some huge fines upon discovering the environmental damage caused by
the defending facility. This type of issues needs to be addressed before making any final decision.

11-80
ST11.2
(a) It is assumed that the current FMS manufacturing technology would prevail
for several years with no major cost and productivity improvement. Therefore,
if the present system is kept for the remaining useful life, it will be replaced
by the current FMS technology with the same investment and O&M costs.
(b)
Defender:

Current Age= MARR= 15%
UCC= 110000 N= 5
dE= 30%
Year 0 1 2 3 4 5
Income Statement
Revenues - - - - -
Expenses
O&M 105,000 115,000 125,000 135,000 145,000
Overhaul
CCA @dE 33,000 23,100 16,170 11,319 7,923
Taxable income (138,000) (138,100) (141,170) (146,319) (152,923)
Income taxes @ t (55,200) (55,240) (56,468) (58,528) (61,169)
Net income (82,800) (82,860) (84,702) (87,791) (91,754)
Cash Flow Statement
Net income (82,800) (82,860) (84,702) (87,791) (91,754)
CCA 33,000 23,100 16,170 11,319 7,923
Disposal tax effect 12,000 7,395
Net cash flow (128,000) (49,800) (59,760) (68,532) (76,472) (76,436)
PE(MARR) = $ (343,278)
AE(MARR) = $ (102,405)

11-81
Challenger:
t= 40%
MARR= 15%
N= 10
dE= 30%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues 664,243 664,243 664,243 664,243 664,243 664,243 664,243 664,243 664,243 664,243
Expenses
O&M 45,000 47,000 49,000 51,000 53,000 55,000 57,000 59,000 61,000 63,000
CCA @dE 345,000 586,500 410,550 287,385 201,170 140,819 98,573 69,001 48,301 33,811
Taxable income 274,243 30,743 204,693 325,858 410,074 468,424 508,670 536,242 554,942 567,432
Income taxes @ t 109,697 12,297 81,877 130,343 164,029 187,370 203,468 214,497 221,977 226,973
Net income 164,546 18,446 122,816 195,515 246,044 281,055 305,202 321,745 332,965 340,459
Cash Flow Statement
Net income 164,546 18,446 122,816 195,515 246,044 281,055 305,202 321,745 332,965 340,459
CCA 345,000 586,500 410,550 287,385 201,170 140,819 98,573 69,001 48,301 33,811
Investment & Salvage (2,300,000) 120,000
Net cash flow (2,300,000) 509,546 604,946 533,366 482,900 447,214 421,873 403,775 390,746 381,266 477,827
PE(MARR) = $ 138,058
AE(MARR) = $ 27,508
Defender's AE value is -$102,405. Challenger's AE value is +$27,508. Replace the defender with the challenger now.

11-82
ST11.3
Tax
CCA Rate= 30%
Current UCC: $14,000

0 $0 $14,000 $5,600 $5,600 $0 $0 $0 $0
1 0 9,800 3,920 3,379 67,500 40,500 34,914 34,914 $4,200 $1,448 $35,686 $41,396
2 0 6,860 2,744 2,039 67,875 40,725 30,265 65,179 2,940 2,322 66,418 41,376
3 0 4,802 1,921 1,231 68,306 40,984 26,257 91,436 2,058 2,850 92,955 41,389
4 0 3,361 1,345 743 68,802 41,281 22,799 114,235 1,441 3,168 115,925 41,429
5 0 2,353 941 448 69,373 41,624 19,817 134,052 1,008 3,360 135,844 41,488
The defender's economic life is two years with AEC = $41,376.

11-83
(a) and (b) Challenger:
t= 40%
MARR= 16%
N= 10
dE= 30%
dB= 10%
Year 0 1 2 3 4 5 6 7 8 9 10
Income Statement
Revenues 57,895 57,895 57,895 57,895 57,895 57,895 57,895 57,895 57,895 57,895
Expenses
O&M 35,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000
CCA @dE 22,710 38,607 27,025 18,917 13,242 9,270 6,489 4,542 3,179 2,226
CCA @dB 2,360 4,484 4,036 3,632 3,269 2,942 2,648 2,383 2,145 1,930
Taxable income (2,175) (20,196) (8,166) 346 6,384 10,684 13,759 15,970 17,571 18,739
Income taxes @ t (870) (8,078) (3,266) 138 2,554 4,273 5,503 6,388 7,028 7,496
Net income (1,305) (12,118) (4,899) 207 3,830 6,410 8,255 9,582 10,543 11,244
Cash Flow Statement
Net income (1,305) (12,118) (4,899) 207 3,830 6,410 8,255 9,582 10,543 11,244
CCA-Equip 22,710 38,607 27,025 18,917 13,242 9,270 6,489 4,542 3,179 2,226
CCA-Bldg 2,360 4,484 4,036 3,632 3,269 2,942 2,648 2,383 2,145 1,930
Equipment (151,400) 5,570
Building (47,200) -
Disposal tax effect-Equip (151)
Disposal tax effect-Bldg 6,949
Net cash flow (198,600) 23,765 30,973 26,161 22,757 20,341 18,622 17,392 16,507 15,867 27,767
PE(MARR) = $ (86,783)
AE(MARR) = $ (17,955)

11-84
Defender's AEC = $41,376. Challenger's AEC = $17,955. Challenger costs much less.
Replace the defender with the challenger.

11-85
ST11.4 Option 1:
Defender for eight more years
UCC= 17,143 N= 8
dE= 30%
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenues - - - - - - - -
Expenses
O&M 31,986 32,785 33,663 34,630 35,692 36,,861 38,147 39,562
Overhaul
CCA @dE 5,143 3,600 2,520 1,764 1,235 864 605 424
Taxable income (37,129) (36,385) (36,183) (36,394) (36,927) (37,725) (38,752) (39,986)
Income taxes @ t (14,852) (14,554) (14,473) (14,558) (14,771) (15,090) (15,501) (15,994)
Net income (22,277) (21,831) (21,710) (21,836) (22,156) (22,635) (23,251) (23,991)
Cash Flow Statement
Net income (22,277) (21,831) (21,710) (21,836) (22,156) (22,635) (23,251) (23,991)
CCA 5,143 3,600 2,520 1,764 1,235 864 605 424
Net cash flow (30,857) (17,134) (18,231) (19,190) (20,072) (20,921) (21,771) (22,646) (23,172)
PE(MARR) = $(129,609)
AE(MARR) = $ (26,091)

11-86
Option 2:
Defender for one more year and switch to a brand new machine

UCC= 17,143 N= 1
dE= 30%
Year 0 1
Income Statement
Revenues -
Expenses
O&M 31986
Overhaul
CCA @dE 5,143
Taxable income (37,129)
Income taxes @ t (14,852)
Net income (22,277)
Cash Flow Statement
Net income (22,277)
CCA 5,143
Disposal tax effect 9,143 (7,200)
Net cash flow (30,857) 5,666
PE(MARR) = $ (25,799)
AE(MARR) = $ (28,894)

11-87
Option 3:
Challenger: Buy the Used Equipment
t= 40%
MARR= 12%
N= 8
dE= 30%
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenues 36,000 36,000 36,000 36,000 36,000 36,000 36,000 36,000
Expenses
O&M 26,500 26,950 27,445 27,990 28,590 29,245 29,950 30,745
CCA @dE 23,730 40,341 28,239 19,767 13,837 9,686 6,780 4,746
Taxable income (14,230) (31,291) (19,684) (11,757) (6,427) (2,931) (730) 509
Income taxes @ t (5,692) (12,516) (7,873) (4,703) (2,571) (1,172) (292) 204
Net income (8,538) (18,775) (11,810) (7,054) (3,856) (1,759) (438) 305
Cash Flow Statement
Net income (8,538) (18,775) (11,810) (7,054) (3,856) (1,759) (438) 305
CCA 23,730 40,341 28,239 19,767 13,837 9,686 6,780 4,746
Net cash flow (158,200) 15,192 21,566 16,428 12,713 9,981 7,927 6,342 9,481
PE(MARR) = $ (91,293)
AE(MARR) = $ (18,377)
Challenger: The Brand-New Equipment

t= 40%
MARR= 12%

11-88
N= 8
dE= 30%
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenues 36,000 36,000 36,000 36,000 36,000 36,000 36,000 36,000
Expenses
O&M 25,350 25,755 26,201 26,691 27,231 27,821 28,455 29,171
CCA @dE 31,568 53,665 37,565 26,296 18,407 12,885 9,019 6,314
Taxable income (20,918) (43,420) (27,766) (16,987) (9,638) (4,705) (1,474) 516
Income taxes @ t (8,367) (17,368) (11,106) (6,795) (3,855) (1,882) (590) 206
Net income (12,551) (26,052) (16,659) (10,192) (5,783) (2,823) (885) 310
Cash Flow Statement
Net income (12,551) (26,052) (16,659) (10,192) (5,783) (2,823) (885) 310
CCA 31,568 53,665 37,565 26,296 18,407 12,885 9,019 6,314
Net cash flow (210,450) 19,017 27,613 20,906 16,104 12,624 10,062 8,135 12,516
PE(MARR) = $ (125,348)
AE(MARR) = $ (25,233)
(a) If the service life is very long, the best option is to replace the current equipment with the used equipment right now and use it
for eight years.
(b) If the service life is eight years, the best option is still the same.

11-89
ST11.5

11-90

11-91
(c)
Economic life of defender
Tax
CCA Rate= 30%

0 $75,000 $53,572 $66,429 $66,429 $0 $0 $0 $0
1 60,000 37,501 51,000 44,348 113,328 67,997 59,128 59,128 $16,072 $5,590 $75,618 $86,961
2 50,000 26,250 40,500 30,624 113,328 67,997 51,415 110,543 11,250 8,993 137,355 84,489
3 30,000 18,375 25,350 16,668 109,632 65,779 43,251 153,794 7,875 11,064 192,491 84,306
4 30,000 12,863 23,145 13,233 109,632 65,779 37,609 191,403 5,513 12,325 232,274 81,358
5 10,000 9,004 9,602 4,774 105,936 63,562 31,601 223,005 3,859 13,092 271,568 81,013
The defender's economic life is five years with AEC = $81,013.

11-92
(c)
Economic life of challenger
Initial Price= $400,000 Tax rate= 40%

CCA Rate= 30%
Holding Undeprec A/T PV of A/T PV of Cum. PV Capital Cum. PV Total Total

Period Market Capital Market Market O&M O&M O&M of O&M Cost of CCA PV AE
0 400,000 400000 $400,000 $400,000 0$ - $ - $ -
1 300,000 340000 $316,000 $274,783 84900 $ 50,940 $ 44,296 $ 44,296 60000 $ 20,870 $148,643 $170,940
2 240,000 238000 $239,200 $180,870 87900 $ 52,740 $ 39,879 $ 84,175 102000 $ 51,720 $251,585 $154,754
3 190,000 166600 $180,640 $118,774 87267 $ 52,360 $ 34,428 $118,602 71400 $ 70,499 $329,330 $144,239
4 150,000 116620 $136,648 $ 78,129 92933 $ 55,760 $ 31,881 $150,483 49980 $ 81,929 $390,425 $136,752
5 115,000 81634 $101,654 $ 50,540 95467 $ 57,280 $ 28,478 $178,962 34986 $ 88,887 $439,535 $131,120
Challenger's economic life is five years with AEC = $131,120.

11-93

11-94
(d) Economic life of defender
Tax
CCA Rate= 30%

0 $75,000 $53,572 $66,429 $66,429 $0 $0 $0 $0
1 60,000 37,501 51,000 44,348 125,831 75,499 65,651 65,651 $16,072 $5,590 $82,142 $94,463
2 50,000 26,250 40,500 30,624 136,228 81,737 61,805 127,456 11,250 8,993 154,268 94,893
3 30,000 18,375 25,350 16,668 139,714 83,828 55,119 182,574 7,875 11,064 221,271 96,912
4 30,000 12,863 23,145 13,233 144,944 86,966 49,723 232,298 5,513 12,325 273,168 95,681
5 10,000 9,004 9,602 4,774 144,864 86,918 43,214 275,511 3,859 13,092 324,074 96,676
The defender's economic life is one year with AEC = $94,463.

11-95
(d) Economic life of challenger
Initial Price= $400,000 Tax rate= 40%

CCA Rate= 30%
Holding Undeprec A/T PV of A/T PV of Cum. PV Capital Cum. PV Total Total

Period Market Capital Market Market O&M O&M O&M of O&M Cost of CCA PV AE
0 400,000 400000 $400,000 $400,000 0$ - $ - $ -
1 300,000 340000 $316,000 $274,783 94725 $ 56,835 $ 49,422 $ 49,422 60000 $ 20,870 $153,770 $176,835
2 240,000 238000 $239,200 $180,870 106275 $ 63,765 $ 48,216 $ 97,637 102000 $ 51,720 $265,047 $163,035
3 190,000 166600 $180,640 $118,774 111832 $ 67,099 $ 44,119 $141,756 71400 $ 70,499 $352,483 $154,380
4 150,000 116620 $136,648 $ 78,129 123888 $ 74,333 $ 42,500 $184,256 49980 $ 81,929 $424,198 $148,582
5 115,000 81634 $101,654 $ 50,540 131573 $ 78,944 $ 39,249 $223,505 34986 $ 88,887 $484,078 $144,408
Challenger's economic life is five yeas with AEC = $144,408.
Still keep the defender for now.

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11-1

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Chapter 11 Replacement Decisions

Sunk Costs, Opportunity Costs, and Cash Flows

(a) Purchase price = $18,000

(b) Opportunity cost = $7,000

(c) Operating the truck for two years

(d) Operating the truck for five years:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

(a) Opportunity cost = $35,000

(c) Using the challenger for eight years:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

(a) Initial cash outlay for the new machine = $130,000

(b) Cash flows for defender over five years:

(c) Using the challenger for seven years:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Defender: Annual profit = $(19 12)*3,000 = $21,000

Challenger: Annual profit = $(19 11)*3,000 = $24,000

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Economic Service Life

Year OC MV AEOC CR AEC

The defender's economic life is two years with AEC = $6,554.

Since the AEC of the defender is larger, replace it now.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Year OC MV AEOC CR AEC AE

The economic life is four years with the largest AE of $936.

Interest rate Economic life Maximum AE value

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Year OC MV AEOC CR AEC

At 10%, the economic life is three years with AEC = $7,724.

Year OC MV AEOC CR AEC

At 20%, the economic life is four years with AEC = $9,224.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Replacement Decisions With an Infinite Planning Horizon and No Technological Change

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

(a) Opportunity cost = $0

(b) Incremental cash flows:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Keep the defender as it has a lower AEC value.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Year OC MV AEOC CR AEC AE

(a) The economic life is one year.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Year OC MV AEOC CR AEC

The defender's economic life is five years with AEC = $4,227.

Replace the defender as the challenger has a lower AEC value.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Option 1: Keep the old sprayer

Option 2: Sell the old sprayer

Option 1 is better as its AEC is lower.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Replacement Problems With a Finite Planning Horizon

The five options considered above are:

It seems that Option 4 has the lowest PEC value of $17,504.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

The five options considered above are:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Note: The SV value under year 3 is calculated as -$13,000 + $4,000 = -$9,000.