Machine A costs Rs. 45,000 and the operating costs are estimated at Rs. 1,000 for the first year, increasing by Rs. 10,000 per year in the second and subsequent years. Machine B costs Rs. 50,000 and operating costs are Rs. 2,000 for the first year, increasing by Rs. 4,000 per year in the second and subsequent years. If we now have a machine of type A, should we replace it with B? If so, when? Assume that both machines have no resale value and future costs are not discounted. -

Machine A: Cost (C) = Rs. 45000

Machine B: Cost (C) = Rs. 50000

• Yes, machine A should be replaced with machines B, since the minimum average annual cost of machines B is less than that of machines A.

• Since we already have machine A, we should continue operating it till its optimal period, i.e. 3 years, since the annual average cost is minimum. After 3 years, it should be replaced with machine B.