Question

Springfield Ironworks (SI) recently had their furnace break down, and need to quickly purchase a new one to minimize the disruption in their production. They can choose a high quality furnace (H) that costs $110,000 with $4,000 of annual maintenance costs for the 7-year life of the furnace, or a low quality furnace (L) that costs $60,000 with $7,500 in annual maintenance costs for the 4-year life of the furnace. Which furnace should SI choose? What is the annualized cost of their choice? Assume a discount rate of 6%, and ignore all taxes.

Answer 1

H costs $110,000 with $4,000 of annual maintenance costs for the 7-year life,
L costs $60,000 with $7,500 in annual maintenance costs for the 4-year life of the furnace.
r = 6%
H total costs are 110,000 + 4,000/1.06 + 4,000/1.06^2 + ... + 4,000/1.06^7 = $132,329.52
L total costs are 60,000 + 7,500/1.06 + 7,500/1.06^2 + ... + 7,500/1.06^4 = $85,978.29
SI should choose furnace L.
The annualized cost of their choice are:
For H: $18,904.22
For L: $21,497.07