XYZ Limited is contemplating a replacement cycle for new machinery. This machinery will cost Sh100 million to purchase. The operating and maintenance costs for the future years are as follows;

Year 0 1 2 3

Operating and Maintenance Cost Shs.000 0 120,000 130,000 140,000

The resale values of the machinery in the second hand market are as follows;

Year 0 1 2 3

Resale Value Shs. 000 0 80,000 65,000 35,000

Assume;

a. The replacement is by an identical machine

b. There is no inflation, tax or risk c.

The cost of capital is 11%.

Required; Advise XYZ Limited on whether to replace this new machine on a one, two or three year cycle. (Use the equivalent annual cost method)