Question
Florida East Coast (FEC) Railway is considering whether it should replace one of its diesel locomotives now, or continue using it for an additional few
Florida East Coast (FEC) Railway is considering whether it should replace one of its diesel locomotives now, or continue using it for an additional few years. Option A is to purchase a new locomotive and sell the old one. Option B is to refurbish and continue using the old locomotive. A new locomotive would be more efficient, but the current machine still gets the job done. It is estimated that the replacement locomotive would cost $1 million if purchased today, and would last for 30 years. Maintenance costs (before-tax) would be $70,000 in the first year, and would increase by 4% annually for the life of the machine. A new locomotive would be depreciated on a straight-line basis over its economic life (i.e., 30 years), assuming a salvage value of $0. If the old locomotive was sold for scrap metal today, it would provide an after-tax cash (in)flow of $30,000.
The current locomotive has been fully depreciated, but it is estimated that it could last an additional 10 years. However, the existing locomotive would require a major overhaul costing $400,000 if FEC decides to continue using the machine. (This cost would not benefit more than one operating cycle, and so would not be capitalized and depreciated. Rather, this cost would be immediately expensed.) Operating costs (before tax) in the first year are expected to be $120,000 and grow by 2% annually for the remaining life of the machine. It is expected that the locomotive could be sold for scrap metal for $40,000 (after-tax) at the end of 10 years. FEC's operating cash flows are taxed at a rate of 30%, and the firm has a cost of capital of 14%.
Answer the questions below. answers to bewithoutdollar signs, totwo decimal places(e.g., 12.34) using proper cash flow sign convention (i.e., negative for cash outflows, positive for cash inflows). Do not use dollar signs or commas.
Answer for these questions:
NPV of Option A is:
NPV of option B is:
The Equivalent Annual Cost (EAC) of Option A is:
The Equivalent Annual Cost (EAC) of Option B is:
FEC should choose Option A or B?
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