A mine is deciding whether or not to replace its fleet of mine headers. The old headers have a market value of $100,000 each, an annual operating cost of $60,000 each and must be retired in 4 years for safety reasons, when they will fetch $5,000 each from a scrap merchant. A new header costs $180,000, has an annual operating cost of $40,000 and will last for 8 years when it too must be sold for scrap at $5,000. The mine uses a discount rate of 10%.
a) Should the mine replace the mine headers? The consumer price index at the end of June 1999 was 122.3 and at the end of June 2000 it was 126.2.
b) What is the inflation rate for this period?
c) Assuming that inflation will be constant for the next 8 years at this rate, should the discount rate used in (a) have been the inflation rate found in (b) ? Why or why not?