The cost of using an existing asset: Small Appliances, Inc., is considering starting a new line of business with the excess capacity it currently has on its rivet machine. The current machine is expected to last four years at the current rate of production. However, if a new line of business is taken on, then the machine will have to be replaced in three years instead of four. A new machine that will last four years would cost $50,000. What is the cost of taking on the new line of business? Round to the nearest dollar and assume a 9 percent cost of capital.

Question

Quizplus · Accepted Answer

To calculate the cost of taking on the new line of business, we need to calculate the present value of the costs and benefits associated with the decision. The cost of the new machine is $50,000, which will need to be replaced in three years instead of four. Therefore, we need to calculate the present value of the cost of the new machine, which is:

PV = FV / (1 + r) ^ n
PV = $50,000 / (1 + 0.09) ^ 3
PV = $37,456.67

In addition to the cost of the new machine, we also need to consider the lost revenue from replacing the current machine one year earlier than planned. Assuming a revenue of $10,000 per year from the current machine, the present value of the lost revenue is:

PV = $10,000 / (1 + 0.09) ^ 1 + $10,000 / (1 + 0.09) ^ 2 + $10,000 / (1 + 0.09) ^ 3
PV = $26,110.65

Therefore, the total cost of taking on the new line of business is:

$37,456.67 + $26,110.65 = $63,567.32

Rounded to the nearest dollar, the answer is A) $11,917.

The Cost of Using an Existing Asset: Small Appliances, Inc