A company buys a machine and then buys an upgrade which increases its productivity by 100%.The total cost of the machine and the upgrade is $10,000.The upgraded machine has no scrap value at the end of its 10-year estimated lifetime and maintenance is $500 per year.If there was no upgrade,the maintenance would be only $300 per year and the machine's lifetime would be 14 years (scrap value would still be $0).If the upgraded and non-upgraded machines are economically equivalent and if the cost of capital is j₁ = 10%,how much less is the cost of the original (non-upgraded)machine?

Question

Quizplus · Accepted Answer

The present value of the maintenance cost difference over the respective lifetimes, discounted at 10%, is calculated and subtracted from the total cost to find the original machine's cost.

A Company Buys a Machine and Then Buys an Upgrade