Bread Products Ltd is considering the replacement policy for its industrial size ovens which are used as part of a production line that bakes bread. Given its heavy usage, each oven has to be replaced frequently. The choice is between replacing every two years or every three years. Only one type of oven is used, each of which costs £24,500. 

Maintenance costs and resale values are as follows:

Original cost, maintenance costs and resale values are expressed in current prices. That is, for example, maintenance for a two-year-old oven would cost £800 for maintenance undertaken now. It is expected that maintenance costs will increase at 10% per annum and oven replacement cost and resale values at 5% per annum. The money discount rate is 15%. 

Required

1. Calculate the preferred replacement policy for the ovens in a choice between a two-year or three-year replacement cycle. 

2. Identify the limitations of net present value techniques when applied generally to investment appraisal.

Transcribed Image Text:

Year Maintenance per annum Resale value 1 £500 £800 £15 600 £1 500 £11 200