You Are Considering Whether to Replace an Existing Flow Meter

question 48

Essay

You are considering whether to replace an existing flow meter. The existing meter can be sold now for $50 or it can be sold in 1 year for $10. It costs $30 per year to operate and maintain. A new meter costs $400 and has a 10-year life. It could be sold for $40 at the end of its life. The new meter costs $14 per year to operate and maintain. What do you recommend if the cost of capital is 12%?
A._12,10 - $40/(1.12)¹⁰ = $471.87; $4
71.87/5.65 = $83.51
Because the cost of keeping the old machine is less than the cost of the new machine, the old machine should not be replaced.

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Definitions:

Economies of Scale

Refers to the cost advantage achieved when production becomes efficient, as the scale of the output expands, typically resulting in a reduction in average cost per unit through increased production efficiency.

Cycle Inventory

Inventory that turns over regularly in the course of business operations, representing the portion of inventory intended to meet normal demand.

Supply Chain

The network between a company and its suppliers to produce and distribute a specific product to the final buyer.

Cycle Inventory

Inventory maintained to cater to the expected demand of customers over a given cycle time, effectively acting as a buffer to ensure smooth operations.