Question

Stemway Company requires a new manufacturing facility. It found three locations: all of which would provide the needed capacity, the only difference is the price. Location A may be purchased for $500,000. Location B may be acquired with a down payment of $100.000 and annual payments at the end of each of the next twenty years of $50.000 Location requires $40,000 payments at the beginning of each of the next twenty-five years. Assuming Stemway's borrowing costs are 8% per annum, which option is the least costly to the company?

Answer 1

Least costly option are that option wherein paid amount would be the lowest one, To Compare all the options we should calculate the present value of payment which is calculated as follows -

Location A

present value of payment = $ 500000*PVIF(8%,0) as it is paid now

= $ 500000*1

= $ 500000

Location B

Present value of payment = $ 100000*PVIF(8%,0) + 50000*PVIFA(8%,20)

= 100000*1 + 50000*9.82

= 100000 + 490907.4

= 590907.4

Location C

Present value of payment = 40000*PVIFA(8%,25)

= 40000*11.52

= 461150.3

Location C would be the least costly option for the company as it has lowest value compare to Location A & B.

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