Claudia works with Lockheed-Martin (LMCO) in the aircraft maintenance division. She is preparing for what she and her boss, the division chief, hope to be a new 10-year defense contract with the U.S. Air Force on C-5A cargo aircraft. A key piece of equipment for maintenance operations is an avionics circuit diagnostics system. The current system was purchased 7 years ago on an earlier contract. It has no capital recovery costs remaining, and the following are reliable estimates: current market value = $70,000, remaining life of3 more years, no salvage value, and AOC = $30,000 per year. The only options for this system are to replace it now or retain it for the full 3 additional years. Claudia has found that there is only one good challenger system. Its cost estimates are: first cost of $750,000, life of 10 years, S = 0, and AOC = $50,000 per year. Realizing the importance of accurate defender alternative cost estimates, Claudia asked the division chief what system would be a logical follow-on to the current one 3 years hence, if LMCO wins the contract. The chief predicted LMCO would purchase the very system she had identified as the challenger, because it is the best on the market. The company would keep it for the entire to additional years for use on an extension of this contract or some other application that could recover the remaining 3 years of invested capital. Claudia interpreted the response to mean that the last 3 years would also be capital recovery years, but on some project other than this one. Claudia’s estimate of the first cost of this same system 3 years from now is $900,000. Additionally, the $50,000 per year AOe is the best estimate at this time. The division chief mentioned any study had to be conducted using the interest rate of 10%, as mandated by the U.S. Office of Management and Budget (OMB).
Perform a replacement study for the fixed contract period of 10 years.