A contractor buys a paver for $70,000. The annual operation costs of the paver (operator salary, fuel, oil, etc.) is $10,000. The tires need to be replaced at the end of the 2nd and 4th year of the service life of the paver. The cost for tire replacement is $12,000 each time. At the end of the 5th year, major repairs will be required. The major repairs will cost $22,000. The contractor plans on selling the paver at the end of year 6 for $5,000.

a). If the contractor’s minimum acceptable rate of return (MARR) is 5% compounded annually, how much profit should the contractor make per year to recover the costs and achieve the MARR? Make sure you draw the cash flow diagram.

b). At the end of the service life of the paver (end of year 6), the contractor is faced with two options. He can either extend the life of the paver for another 5 years, or he can rent a paver instead. If the contractor chooses to extend the life of the paver, he will need to replace the tires at the start of year 7, and once again at the end of year 8. The cost of tire replacement will be $12,000 each time. He will also need major repairs at the start of year 7 which would cost $25,000. He will continue to pay operation costs of $10,000 per year. He can then sell the paver at the end of year 11 for $1,000. Alternatively, he can sell his old paver for the salvage value of $5,000 at the beginning of year 7 and start renting the paver for $45,000 per year. He will not have to worry about changing tires or performing repairs (included in rent cost). However, he will still pay $10,000 in operation costs. Assuming the same MARR of 5% as before, which option should the contractor choose?

Answer rating: 100% (QA)

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