Question

(C) FUPRE Energy Enterprise Ltd is considering which of two mechanical devices to install to reduce costs in a particular situation. Both devices cost N20,000 and have useful lives of 5 years and no salvage value, Device A can be expected to result in N3000 savings annually. Device B will provide cost savings of N4000 in the first year but will decline at N500 annually, making the second-year savings N3500, the third-year savings N3000, and so forth. As a consulting engineer to the firm, you are required to use the net present worth as a decision support tool to advise FUPRE Enengy Enterprise with interest rate at 10% 25 Marks

Answer 1

Let us take the case of device A

Initial Cost=N20000

Annual savings=N3000

NPW=-20000+3000*(P/A,0.10,5)

Let us calculate the interest factor

(1+i)" (P/A, i,n)=-

1-(1+0. 10) (Ρ/Α, 0.10, 5) =- 3.790787 0.10

NPW=-20000+3000*3.790787=-N 8627.64

Let us take the case of device B

Initial Cost=N20000

Saving in first year=N4000

Gradient=G=-N500

NPV=-20000+4000*(P/A,0.10,5)-500*(P/G,0.10,5)

(P/G,i,n) = (1+i)" -1 2(1+i) i(1+i)n

(P/G,0.10,5) = (1+0.105-1 0.102(1 + 0.10)5 1 0.10(1+0.10)5

NPV=-20000+4000*3.790787-6.861802*500=-N 8267.75

We can see the PW of both machines is negative. None of the machines should be taken.