Question

2. Old Southwest Canning Co. has determined that any one of four machines can be used in its chili- canning operation. The costs of the machines are estimated below, and all machines have a 5-year life. If the minimum attractive rate of return is 60% per year, determine which machine should be selected on the basis of a rate of return analysis. Machine First Cost, $ AOC, $ 1 -46,000 -26,000 2 -45,000 -27,000 -42,000 -29,000 4 -43,000 -28,000 3/5

Answer 1

We will calculate the present worth (PW) of each of the machine. PW is very similar to NPV. The PW will turn out to be negative. We will select the machine with the least negative PW.

PW = Co + C[1 – (1+r)^n

where C0 = first cost; C = AOC; r = MARR = 60%; and n = life = 5 years.

Hence, for machine 1, PW1 = - 46,000 - 26,000 / 60% x [1 - (1 + 60%)-5] = - 85,200.74

for machine 2, PW2 = - 45,000 - 27,000 / 60% x [1 - (1 + 60%)-5] = - 85,708.47

for machine 3, PW3 = - 42,000 - 29,000 / 60% x [1 - (1 + 60%)-5] = - 85,723.91

for machine 4, PW4 = - 43,000 - 28,000 / 60% x [1 - (1 + 60%)-5] = - 85,216.19

PW1 is the least negative and hence machine 1 should be selected.