iHerb Inc. has several herb extractor evaporators that were purchased four years ago at a price of $20,000. These machines currently require annual maintenance costs of $2,000. However, the maintenance agreement with the manufacturer expires at the end of two years and iHerb expects annual maintenance to increase to $8,000 per year thereafter. The machines could be sold at the current year in marketplace, as is, for $8,000, but the expected sale price will decline to $3,500 at the end of two years. At the end of year 6, the machine's useful life will be over and they will be disposed of as valueless scrap.

iHerb is considering replacing these evaporators with a new machine that will accomplish the same job. The cost of the new machine is $25,000 and the manufacturer offers an 8-year maintenance contract of $1,000 per year. This machine will have an 8-year life and be worthless scrap at the end. Assume both equipment (new & old) is depreciated using 7-yr straight-line depreciation and has a tax rate of 39% (i.e., the old machine still have 4 years depreciation left). At a cost of capital of 7% (assume zero inflation), 

When should iHerb replace its evaporators? compare the situation below:

(1) EAC of continue operating the old machine (2) EAC if replace the old machine now with new machine (3) EAC if wait till end of year 2 to replace the old machine with new machine. (4) EAC if replace the machine till end of year 6).

Answer rating: 100% (QA)

To determine the best time for iHerb to replace its evaporators we need to compare the Equivalent Annual Costs EAC for different scenarios EAC takes i... View the full answer