Suppose the Norlo Canadian Pacific Railway is considering replacement of a power jack tamper, used for maintenance of track, with a new automatic raising device that can be attached to a production tamper.
The present power jack tamper cost $24,000 five years ago and had an estimated life of 12 years. A year from now, the machine will require a major overhaul estimated to cost $5,000. It can be disposed of now via an outright cash sale for $4,000. There will be no value at the end of another 7 years.
The automatic raising attachment has a delivered selling price of $68,000 and an estimated life of 12 years. Because of anticipated future developments in combined maintenance machines, Norfolk Southern management believes that they would dispose of the machine at the end of the seventh year to take advantage of newly developed machines. Estimated sales value at the end of 7 years is $7,000.
Tests have shown that the automatic raising machine will produce a more uniform surface on the track than does the power jack tamper now in use. The new equipment will eliminate one labourer whose annual compensation, including employee benefits, is $30,000.
Track maintenance work is seasonal, and the equipment normally works from May 1 to October 31 each year. Machine operators and labourers are transferred to other work after October 31, at the same rate of pay.
The salesperson claims that the annual normal maintenance of the new machine will run about $1,000 per year. Because the automatic raising machine is more complicated than the manually operated machine, it will probably require a thorough overhaul at the end of the fourth year, at an estimated cost of $7,000.
Records show the annual normal maintenance of the power jack tamper to be $1,200. Fuel consumption of the two machines is equal. Should CPR keep or replace the power jack tamper? The company requires a 10 percent rate of return. Compute NPV. Ignore income taxes.
