The data on the running cost per year and resale price of equipment ‘A’, whose purchase price is Rs. 2,00,000, are as follows: - |Year| 1| 2| 3| 4| 5| 6| 7| |-|-|-|-|-|-|-|-| |Running Cost (Rs.)| 30,000| 38,000| 46,000| 58,000| 72,000| 90,000| 1,10,000| |Resale Value (Rs.)| 1,00,000| 50,000| 25,000| 12,000| 8,000| 8,000| 8,000|

i. What is the optimum period of replacement? - ii. When equipment A is two years old, equipment B, which is a new model for the same usage, is available. The optimum period for replacement is 4 years, with an average cost of Rs. 72,000. Should equipment A change with equipment B? If so, when? -

Cost of equipment A (i.e. C) = Rs. 2,00,000

The following table calculates the average annual cost:

i. The average annual cost is lowest after 5 years, i.e. in the 5th year row in the table.

So the machine should be replaced after 5 years of use.

ii. When equipment A is 2 years old, there is now a new model, B, available.

This new model, B, has an optimum replacement period of 4 years, and an average (annual) cost of Rs. 72,000. This average cost is way lower than A’s minimum average cost of Rs. 87,000.

So equipment A should be replaced with equipment B, since B has lower average costs.

Since A is already 2 years old, let it be used for its optimum period of 5 years. So we’ll replace it with B 3 years hence, i.e. after A has completed 5 years.