CHEMICAL ENGINEERING

ECONOMICS

6th Semester,
B.Sc. Chemical Engineering
Session 2015

Delivered by:
Dr Usman Ali

Department of Chemical Engineering

University of Engineering & Technology, Lahore
 PROFITABILITY,
ALTERNATIVE INVESTMENTS,
AND REPLACEMENTS
 Introduction
➢ The word profitability is used as the general term for
the measure of the amount of profit that can be
obtained from a given situation.
➢ Before capital is invested in a project or enterprise, it is
necessary to know how much profit can be obtained
and whether or not it might be more advantageous to
invest the capital in another form of enterprise.
➢ Thus, the determination and analysis of profits
obtainable from the investment of capital and the
choice of the best investment among various
alternatives are major goals of an economic analysis.
➢ There are many reasons why capital investments are
made.
➢ Sometimes, the purpose is merely to supply a service
which cannot possibly yield a monetary profit, such as
the provision of recreation facilities for free use of
employees.
➢ The profitability for this type of venture cannot be
expressed on a positive numerical basis.
➢ The design engineer, however, usually deals with
investments which are expected to yield a tangible profit.
➢ Because profits and costs are considered which
will occur in the future, the possibilities of
inflation or deflation affecting future profits and
costs must be recognized.
➢ Investments may be made for replacing or
improving an existing property, for developing a
completely new enterprise, or for other purposes
wherein a profit is expected from the outlay of
capital.
➢ For cases of this sort, it is extremely important to
make a careful analysis of the capital utilization.
 Profitability Standards
➢ This profitability standard, which can normally be expressed on a
direct numerical basis, must be weighed against the overall
judgment evaluation for the project in making the final decision as
to whether or not the project should be undertaken.
➢ The judgment evaluation must be based on the recognition that a
quantified profitability standard can serve only as a guide.
➢ Thus, it must be recognized that the profit evaluation is based on a
prediction of future results so that assumptions are necessarily
included.
➢ Many intangible factors, such as future changes in demand or
prices, possibility of operational failure, or premature obsolescence,
cannot be quantitized.
➢ It is in areas of this type that judgment becomes critical in making a
final investment decision.
➢ A primary factor in the judgment decision is the
consideration of possible alternatives.
➢ For example, the alternatives to continuing the operation of
an existing plant may be to replace it with a more efficient
plant, to discontinue the operation entirely, or to make
modifications in the existing plant. In reaching the final
decision, the alternatives should be considered two at a
time on a mutually exclusive basis.
➢ An obvious set of alternatives involves either making the
capital investment in a project or investing the capital in a
safe venture for which there is essentially no risk and a
guaranteed return. In other words, the second alternative
involves the company’s decision as to the cost of capital.
 Bases for Evaluating Project
Profitability
➢ Total profit alone cannot be used as the deciding
profitability factor in determining if an
investment should be made.
➢ The profit goal of a company is to maximize
income above the cost of the capital which must
be invested to generate the income.
➢ If the goal were merely to maximize profits, any
investment would be accepted which would give
a profit, no matter how low the return or how
great the cost.
For example, suppose that two equally sound investments can
be made. One of these requires $100,000 of capital and will
yield a profit of $lO,OOO/year, and the second requires $1
million of capital and will yield $25,0OO/year. The second
investment gives a greater yearly profit than the first, but the
annual rate ofreturn on the second investment is only
($25,000/$1,000,000) x (100) = 2.5 percent
while the annual rate of return on the $100,000 investment is
10 percent. Because reliable bonds and other conservative
investments will yield annual rates of return in the range of 6
to 9 percent, the $1 million investment in this example would
not be very attractive; however, the 10 percent return on the
$100,000 capital would make this investment worthy of
careful consideration.
➢ The basic aim of a profitability analysis is to give a measure of the
attractiveness of the project for comparison to other possible
courses of action.
➢ It is, therefore, very important to consider the exact purpose of a
profitability analysis before this standard reference or base case is
chosen.
➢ If the purpose is merely to present the total profitability of a given
project, a simple statement of total profit per year or annual rate of
return may be satisfactory.
➢ On the other hand, if the purpose is to permit comparison of
several different projects in which capital might be invested, the
method of analysis should be such that all cases are on the same
basis so that direct comparison can be made among the
appropriate alternatives.
Mathematical Methods for Profitability
Evaluation
1. Rate of return on investment
2. Discounted cash flow based on full-life
performance
3. Net present worth
4. Capitalized costs
5. Payout period
 Returns Incorporating Minimum
Profits as an Expense
➢ Another method which is sometimes used for reporting rate of
return is based on the assumption that it must be possible to
obtain a certain minimum profit or return from an investment
before the necessary capital outlay will be desirable.
➢ This minimum profit is included as a fictitious expense along with
the other standard expenses.
➢ When return on investment is determined in this manner, the result
shows the risk earning rate, and represents the return over and
above that necessary to make the capital expenditure advisable.
➢ If the return is zero or larger, the investment will be attractive. This
method is sometimes designated as return bused on capital
recovery with minimum profit.
 Rate of Return on Investment
➢ In engineering economic studies, rate of return on investment is
ordinarily expressed on an annual percentage basis. The yearly
profit divided by the total initial investment necessary represents
the fractional return, and this fraction times 100 is the standard
percent return on investment.
➢ Profit is defined as the difference between income and expense.
➢ Therefore, profit is a function of the quantity of goods or services
produced and the selling price.
➢ The amount of profit is also affected by the economic efficiency of
the operation, and increased profits can be obtained by use of
effective methods which reduce operating expenses.
 Rate of Return on Investment
➢ To obtain reliable estimates of investment returns, it is
necessary to make accurate predictions of profits and
the required investment.
➢ To determine the profit, estimates must be made of
direct production costs, fixed charges including
depreciation, plant overhead costs, and general
expenses.
➢ Profits may be expressed on a before-tax or after-tax
basis, but the conditions should be indicated. Both
working capital and fixed capital should be considered
in determining the total investment.
➢ The inclusion of minimum profit as an expense is rather
unrealistic, especially when it is impossible to designate the
exact return which would make a given investment
worthwhile.
➢ One difficulty with this method is the tendency to use a
minimum rate of return equal to that obtained from
present investments.
➢ This, of course, gives no consideration to the element of
risk involved in a new venture.
➢ Despite these objections, the use of returns incorporating
minimum profits as an expense is acceptable providing the
base, or minimum return and the general method
employed are clearly indicated.
➢The methods for determining rate of return,
as presented in the preceding sections, give
“point values” which are either applicable for
one particular year or for some sort of
“average” year.
➢They do not consider the time value of money,
and they do not account for the fact that
profits and costs may vary significantly over
the life of the project.
➢One example of a cost that can vary during the
life of a project is depreciation cost.
➢If straight-line depreciation is used, this cost
will remain constant; however, it may be
advantageous to employ a declining-balance
or sum-of-the-years-digits method to
determine depreciation costs, which will
immediately result in variations in costs and
profits from one year to another.
➢ Other predictable factors, such as increasing
maintenance costs or changing sales volume, may also
make it necessary to estimate year-by-year profits with
variation during the life of the project.
➢ For these situations, analyses of project profitability
cannot be made on the basis of one point on a flat
time-versus-earning curve, and profitability analyses
based on discounted cash flow may be appropriate.
➢ Similarly, time-value-of-money considerations may
make the discounted- cash-flow approach desirable
when annual profits are constant.
 DISCOUNTED CASH FLOW
Rate of Return Based on Discounted Cash Flow
➢ The method of approach for a profitability evaluation by discounted
cash flow takes into account the time value of money and is based
on the amount of the investment that is unreturned at the end of
each year during the estimated life of the project.
➢ A trial-and-error procedure is used to establish a rate of return
which can be applied to yearly cash flow so that the original
investment is reduced to zero (or to salvage and land value plus
working-capital investment) during the project life.
➢ Thus, the rate of return by this method is equivalent to the
maximum interest rate (normally, after taxes) at which money could
be borrowed to finance the project under conditions where the net
cash flow to the project over its life would be just sufficient to pay
all principal and interest accumulated on the outstanding principal.
To illustrate the basic principles involved in discounted-cash-flow calculations
and the meaning of rate of return based on discounted cash flow, consider
the case of a proposed project for which the following data apply:
Initial fixed-capital investment = $100,000
Working-capital investment = $10,000
Service life = 5 years
Salvage value at end of service life = $10,000
➢ Designate the discounted-cash-flow rate of return as i. This rate of
return represents the after-tax interest rate at which the
investment is repaid by proceeds from the project.
➢ It is also the maximum after-tax interest rate at which funds could
be borrowed for the investment and just break even at the end of
the service life.
➢ At the end of five years, the cash flow to the project, compounded
on the basis of end-of-year income, will be
($30,000)(1 + i)4 + ($31,000)(1 + i)3 + ($36,000)(1 + i)2 +($40,000)(1 + i)
+ $43,000 = S
➢ The symbol S represents the future worth of the proceeds to the
project and must just equal the future worth of the initial
investment compounded at an interest rate i corrected for salvage
value and working capital.
➢ Some of the tedious and time-consuming calculations
can be eliminated by applying a discount factor to the
annual cash flows and summing to get a present value
equal to the required investment.
➢ The discount factor for end-of-year payments and
annual compounding is

➢ where i = rate of return n’ = year of project life to

which cash flow applies This discount factor, dn, is the
amount that would yield one dollar after n’ years if
invested at an interest rate of i.
 NET PRESENT WORTH
➢ In the preceding treatment of discounted cash flow, the
procedure has involved the determination of an index
or interest rate which discounts the annual cash flows
to a zero present value when properly compared to the
initial investment.
➢ This index gives the rate of return which includes the
profit on the project, payoff of the investment, and
normal interest on the investment.
➢ A related approach, known as the method of net
present worth (or net present value or venture worth),
substitutes the cost of capital at an interest rate i for
the discounted-cash-flow rate of return.
➢ The cost of capital can be taken as the average rate of
return the company earns on its capital, or it can be
designated as the minimum acceptable return for the
project. The net present worth of the project is then the
difference between the present value of the annual cash
flows and the initial required investment.
➢ To illustrate the method for determining net present worth,
consider the example presented in Table 1 for the case
where the value of capital to the company is at an interest
rate of 15 percent. Under these conditions, the present
value of the cash flows is $127,000 and the initial
investment is $110,000. Thus, the net present worth of the
project is
$127,000 - $110,000 = $17,000
 CAPITALIZED COSTS
➢ The capitalized-cost profitability concept is useful
for comparing alternatives which exist as possible
investment choices within a single overall project.
➢ For example, if a decision based on profitability
analysis were to be made as to whether stainless
steel or mild steel should be used in a chemical
reactor as one part of a chemical plant,
capitalized-cost comparison would be a useful
and appropriate approach.
➢ Capitalized cost related to investment represents the amount of money
that must be available initially to purchase the equipment and
simultaneously provide sufficient funds for interest accumulation to
permit perpetual replacement of the equipment.
➢ If only one portion of an overall process to accomplish a set objective is
involved and operating costs do not vary, then the alternative giving the
least capitalized cost would be the desirable economic choice.
➢ The basic equation for capitalized cost for equipment can be written as
follows:
 PAYOUT PERIOD
➢ Payout period, or payout time, is defined as the
minimum length of time theoretically necessary to
recover the original capital investment in the form of
cash flow to the project based on total income minus
all costs except depreciation.
➢ Generally, for this method, original capital investment
means only the original, depreciable, fixed-capital
investment, and interest effects are neglected.
➢ Thus,
➢ Another approach to payout period takes the time value of money into
consideration and is designated as payout period including interest.
➢ With this method, an appropriate interest rate is chosen representing the
minimum acceptable rate of return.
➢ The annual cash flows to the project during the estimated life are
discounted at the designated interest rate to permit computation of an
average annual figure for profit plus depreciation which reflects the time
value of money.
➢ The time to recover the tied-capital investment plus compounded interest
on the total capital investment during the estimated life by means of the
average annual cash flow is the payout period including interest,

➢ This method tends to increase the payout period above that found with no
interest charge and reflects advantages for projects that earn most of their
profits during the early years of the service life.
 DETERMINING ACCEPTABLE RETURNS
➢ It is often possible to make a profit by the investment
of capital, but it is not always easy to determine if a
given return is sufficient to justify an investment.
➢ Many factors must be considered when deciding if a
return is acceptable, and it is not possible to give one
figure which will apply for all cases.
➢ When dealing with ordinary industrial operations,
profits cannot be predicted with absolute accuracy.
➢ Risk factors, therefore, must be given careful
consideration, and the degree of uncertainty involved
in predicted returns on investments plays an important
role in determining what returns are acceptable.
 DETERMINING ACCEPTABLE RETURNS
➢ A certain amount of risk is involved in any type of investment, but
the degree of risk varies widely for different types of enterprises.
➢ For example, there is very little uncertainty in predicting returns on
capital invested in government bonds, and the chances of losing the
original capital are very small.
➢ However, money invested in a wildcat mining enterprise would
stand a good chance of being lost completely with no return
whatsoever.
➢ If capital is available for investment in a proposed enterprise, it
would also be available for use in other ventures.
➢ Therefore, a good basis for determining an acceptable return is to
compare the predicted return and the risks involved with returns
and risks in other types of investments.
 DETERMINING ACCEPTABLE RETURNS
➢ Very conservative investments, such as government bonds, pay low
returns in the range of 5 to 7 percent, but the risk involved is practically
negligible.
➢ Preferred stocks yield returns of about 7 to 9 percent. There is some risk
involved in preferred-stock investments since a business depression or
catastrophe could cause reduction in returns or even a loss of the major
portion of the capital investment.
➢ Common stocks may yield very high returns; however, the returns
fluctuate considerably with varying economic conditions, and there is
always the possibility of losing much or all of the original investment.
➢ It can be stated that moderate risks are involved in common-stock
investments.
➢ Certainly, at least moderate risks are involved in most industrial projects.
In general, a 20 percent return before income taxes would be the
minimum acceptable return for any type of business proposition, even if
the economics appeared to be completely sound and reliable.
 DETERMINING ACCEPTABLE RETURNS
➢ Many industrial concerns demand a predicted pretax
return of at least 30 percent based on reliable
economic estimates before they will consider investing
capital in projects that are known to be well
engineered and well designed.
➢ The final decision as to an acceptable return depends
on the probable accuracy of the predicted return and
on the amount of risk the investor wishes to take.
➢ Availability of capital, personal opinions, and intangible
factors, such as the response of the public to changes
or appearances, may also have an important effect on
the final decision.
 ALTERNATIVE INVESTMENTS
➢ In industrial operations, it is often possible to produce
equivalent products in different ways.
➢ Although the physical results may be approximately the
same, the capital required and the expenses involved can
vary considerably depending on the particular method
chosen.
➢ Similarly, alternative methods involving varying capital and
expenses can often be used to carry out other types of
business ventures.
➢ It may be necessary, therefore, not only to decide if a given
business venture would be profitable, but also to decide
which of several possible methods would be the most
desirable.
➢ The final decision as to the best among alternative investments is
simplified if it is recognized that each dollar of additional investment
should yield an adequate rate of return.
➢ In practical situations, there are usually a limited number of choices, and
the alternatives must be compared on the basis of incremental increases
in the necessary capital investment.
➢ The following simple example illustrates the principle of investment
comparison. A chemical company is considering adding a new production
unit which will require a total investment of $1,200,000 and will yield an
annual profit of $240,000.
➢ An alternative addition has been proposed requiring an investment of $2
million and yielding an annual profit of $300,000. Although both of these
proposals are based on reliable estimates, the company executives feel
that other equally sound investments can be made with at least a 14
percent annual rate of return.
➢ Therefore, the minimum rate of return required for the new investment is
14 percent.
➢ The rate of return on the $1,200,000 unit is 20 percent, and
that for the alternative addition is 15 percent. Both of these
returns exceed the minimum required value, and it might
appear that the $2 million investment should be
recommended because it yields the greater amount of
profit per year.
➢ However, a comparison of the incremental investment
between the two proposals shows that the extra
investment of $800,000 gives a profit of only $60,000, or an
incremental return of 7.5 percent.
➢ Therefore, if the company has $2 million to invest, it would
be more profitable to accept the $1,200,000 proposal and
put the other $800,000 in another investment at the
indicated 14 percent return.
➢ A general rule for making comparisons of alternative
investments can be stated as follows: The minimum
investment which will give the necessary functional results
and the required rate of return should always be accepted
unless there is a specific reason for accepting an alternative
investment requiring more initial capital.
➢ When alternatives are available, therefore, the base plan
would be that requiring the minimum acceptable
investment.
➢ The alternatives should be compared with the base plan,
and additional capital would not be invested unless an
acceptable incremental return or some other distinct
advantage could be shown.
 REPLACEMENTS
➢ The term “replacement,” as used in this chapter, refers
to a special type of alternative in which facilities are
currently in existence and it may be desirable to
replace these facilities with different ones.
➢ Although intangible factors may have a strong
influence on decisions relative to replacements, the
design engineer must understand the tangible
economic implications when a recommendation is
made as to whether or not existing equipment or
facilities should be replaced.
The reasons for making replacements can be divided into two general
classes, as follows:
1. An existing property must be replaced or changed in order to
continue operation and meet the required demands for service or
production. Some examples of reasons for this type of necessary
replacement are:
a. The property is worn out and can give no further useful service.
b. The property does not have sufficient capacity to meet the demand placed upon it.
c. Operation of the property is no longer economically feasible because changes in
design or product requirements have caused the property to become obsolete.
2. An existing property is capable of yielding the necessary product or
service, but more efficient equipment or property is available which
can operate with lower expenses.
➢ When the reason for a replacement falls in the first general type,
the only alternatives are to make the necessary changes or else go
out of business. Under these conditions, the final economic analysis
is usually reduced to a comparison of alternative investments.
➢ The correct decision as the the desirability of replacing an existing
property which is capable of yielding the necessary product or
service depends on a clear understanding of theoretical
replacement policies plus a careful consideration of many practical
factors.
➢ In order to determine whether or not a change is advisable, the
operating expenses with the present equipment must be compared
with those that would exist if the change were made.
➢ Practical considerations, such as amount of capital available or
benefits to be gained by meeting a competitor’s standards, may
also have an important effect on the final decision.
 Methods of Profitability Evaluation
for Replacements
➢ The same methods that were explained and applied earlier in this
chapter are applicable for replacement analyses. Net-present-worth
and discounted-cashflow methods give the soundest results for
maximizing the overall future worth of a concern.
➢ However, for the purpose of explaining the basic principles of
replacement economic analyses, the simple rate-of-return-on-
investment method of analysis is just as effective as those methods
involving the time value of money.
➢ Thus, to permit the use of direct illustrations which will not detract
from the principles under consideration, the following analysis of
methods for economic decisions on replacements uses the annual
rate of return on initial investment as the profitability measure.
➢ The identical principles can be treated by more complex rate-of-
return and net-present-worth solutions by merely applying the
methods described earlier in this chapter.
 Book Values and Unamortized Values
➢ The difference between the book value and the net realizable value at any
time is commonly designated as the unamortized value. In the example,
the unamortized value was $15,000 - $6000 = $9000. This means that a
$9000 loss was incurred because of incorrect estimation of depreciation
allowances.
➢ Much of the confusion existing in replacement studies is caused by
unamortized values. Some individuals feel that a positive unamortized
value represents a loss which would be caused by making a replacement.
➢ This is not correct because the loss is a result of past mistakes, and the
fact that the error was not apparent until a replacement was considered
can have no bearing on the conditions existing at the present time.
➢ When making theoretical replacement studies, unamortized values must
be considered as due to past errors, and these values are of no
significance in the present decision as to whether or not a replacement
should be made.
 Investment on which Replacement
Comparison is Based
➢ As indicated in the preceding section, the unamortized
value of an existing property is based on past conditions
and plays no part in a replacement study. The advisability of
making a replacement is usually determined by the rate of
return which can be realized from the necessary
investment.
➢ It is, therefore, important to consider the amount of the
investment. The difference between the total cost of the
replacement property and the net realizable value of the
misting property equals the necessary investment.
➢ Thus, the correct determination of the investment involves
only consideration of the present capital outlay required if
the replacement is made.
 Net Realizable Value
➢ In replacement studies, the net realizable value of
an existing property should be assumed to be the
market value.
➢ Although this may be less than the actual value of
the property as far as the owner is concerned, it
still represents the amount of capital which can
be obtained from the old equipment if the
replacement is made.
➢ Any attempt to assign an existing property a
value greater than the net realizable value tends
to favor replacements which are uneconomical.
 Activity
A proposed chemical plant will require a fixed
capital investment of $10 million. It is estimated
that the working capital will amount to 25
percent of the total investment, and annual
depreciation costs are estimated to be 10
percent of the fixed-capital investment. If the
annual profit will be $3 million, determine the
standard percent return on the total investment
and the minimum payout period.
 Activity
An investigation of a proposed investment has
been made. The following result has been
presented to management: The minimum
payout period based on capital recovery using a
minimum annual return of 10 percent as a
fictitious expense is 10 years; annual
depreciation costs amount to 8 percent of the
total investment. Using this information,
determine the standard rate of return on the
investment.
 Activity
The information given in Prob. 2 applies to
conditions before income taxes. If 34 percent of
all profits must be paid out for income taxes,
determine the standard rate of return after
taxes using the figures given in previous
problem.
 Activity
A heat exchanger has been designed and insulation is being considered for
the unit. The insulation can be obtained in thickness of 1, 2, 3, or 4 in. The
following data have been determined for the different insulation thicknesses:

What thickness of insulation should be used? The value of heat is 30

tents/1,000,000 Btu. An annual return of 15 percent on the fixed-capital
investment is required for any capital put into this type of investment. The
exchanger operates 300 days per year.
 Activity
A company must purchase one reactor to be used in an overall
operation. Four reactors have been designed, all of which are
equally capable of giving the required service. The following data
apply to the four designs:

If the company demands a 15 percent return on any unnecessary

investment, which of the four designs should be accepted?
 Activity
The capitalized cost for a piece of equipment has
been found to be $55,000. This cost is based on the
original cost plus the present value of an indefinite
number of renewals. An annual interest rate of 12
percent was used in determining the capitalized
cost. The salvage value of the equipment at the end
of the service life was taken to be zero, and the
service life was estimated to be 10 years. Under
these conditions, what would be the original cost of
the equipment?
 Activity
An existing warehouse is worth $500,000, and the average value of the
goods stored in it is $400,000. The annual insurance rate on the
warehouse is 1.1 percent, and the insurance rate on the stored goods
is 0.95 percent. If a proposed sprinkling system is installed in the
warehouse, both insurance rates would be reduced to three-quarters
of the original rate. The installed sprinkler system would cost $20,000,
and the additional annual cost of maintenance, inspection, and taxes
would be $300. The required write-off period for the entire investment
in the sprinkler system is 20 years. The capital necessary to make the
investment is available. The operation of the warehouse is now giving
an 8 percent return on the original investment. Give reasons why you
would or would not recommend installing the sprinkler system.
 Activity
A power plant for generating electricity is one part of a plant-design proposal.
Two alternative power plants with the necessary capacity have been
suggested. One uses a boiler and steam turbine while the other uses a gas
turbine. The following information applies to the two proposals:

All other costs are the same for either type of power plant. A 12 percent
return is required on any investment. If one of these power plants must be
accepted, which one should be recommended?
 Activity
The facilities of an existing chemical company must be increased if the
company is to continue in operation. There are two alternatives. One of the
alternatives is to expand the present plant. If this is done, the expansion
would cost $130,000. Additional labor costs would be $150,000 per year,
while additional costs for overhead, depreciation, taxes, and insurance would
be $60,000 per year. A second alternative requires construction and operation
of new facilities at a location about 50 miles from the present plant. This
alternative is attractive because cheaper labor is available at this location. The
new facilities would cost $200,000. Labor costs would be $120,000 per year.
Overhead costs would be $70,000 per year. Annual insurance and taxes would
amount to 2 percent of the initial cost. All other costs except depreciation
would be the same at each location. If the minimum return on any acceptable
investment is 9 percent, determine the minimum service life allowable for the
facilities at the distant location for this alternative to meet the required
incremental return. The salvage value should be assumed to be zero, and
straight-line depreciation accounting may be used.
 Activity
A chemical company is considering replacing a batch-wise reactor with
a modernized continuous reactor. The old unit cost $40,000 when new
5 years ago, and depreciation has been charged on a straight-line basis
using an estimated service life of 15 years and final salvage value of
$1000. It is now estimated that the unit has a remaining service life of
10 years and a final salvage value of $1000. The new unit would cost
$70,000 and would result in an increase of $5000 in the gross annual
income. It would permit a labor saving of $7000 per year. Additional
costs for taxes and insurance would be $1000 per year. The service life
is estimated to be 12 years with a final salvage value of $1000. All costs
other than those for labor, insurance, taxes, and depreciation may be
assumed to be the same for both units. The old unit can now be sold
for $5000. If the minimum required return on any investment is 15
percent, should the replacement be made?
 Activity
The owner of a small antifreeze plant has a small canning unit
which cost him $5000 when he purchased it 10 years ago. The
unit has completely depreciated, but the owner estimates
that it will still give him good service for 5 more years. At the
end of 5 years the unit will be worth a junk value of $100. The
owner now has an opportunity to buy a more efficient
canning unit for $6000 having an estimated service life of 10
years and zero salvage or junk value. This new unit would
reduce annual labor and maintenance costs by $1000 and
increase annual expenses for taxes and insurance by $100. All
other expenses except depreciation would be unchanged. If
the old canning unit can be sold for $600, what replacement
return on his capital investment will the owner receive if he
decides to make the replacement?