Question

X=04

Q5. [20 marks] For this question, X is the first two digits (from the right) of your student ID. Wolfpack Inc., a textile manufacturing company, is considering opening a production and shipping facility to keep up with demand for its pillows. The facility is expected to require an initial investment of $190,000 and will have a $36,000 salvage value after 5 years. Net annual revenue is estimated to be $100,000 while annual maintenance costs are estimated to be X% of the annual revenue. Determine how sensitive the decision to invest in the new facility is to the estimates of initial cost and annual revenues. Use a MARR of 4% per year and a 5 years study period (If your student ID number is even, use the PW method. Otherwise, use the FW method)

Answer 1

Ans)-

Take X = 04 i.e. Annual maintenance costs is 4% of the annual revenue.

Given,

Initial investment (outflow) = $190,000

Salvage value (inflow)= $36,000

Annual revenue (Annual inflows) = $100,000

Annual maintenance costs (annual outflows) = 4% of 100,000 = 100,000*4/100 = $4,000

Net annual flows = annual inflows - annual outflows

                                = 100,000 – 4,000 = $96,000

Hence using Present worth (PW) method-

Present Worth (PW) = A, + A1 A2 + (1+r)1 (1+r)2 + An (1+r)"

Where,

A₀,A₁, A₃, … ,A_n are the cash flows at the end of year 0,1,2,…,n respectively.

r: interest rate

here,

n=5 , r=4% = 0.04

A₀ (initial investment) = 190,000, A₁ = A₂ = A₃ = A₄ = 96,000 (net annual inflows)

A₅ (inflow at the end of year 5) = last net annual inflow + salvage value

                                                        = 96,000 + 36,000 = $132,000

Now,

96,000 96,000 PW = -190,000+ 96,000 + + (1 + 0.04)1 (1+0.04)2'(1 +0.04)3 96,000 132,000 + + (1 + 0.04)4 (1 + 0.04)5

PW = -190,000 + 92,307 + 88, 757 + 85, 348 + 82,051 + 108,500

Present worth (PW) = $266,963

Since the present worth is significantly positive. Hence, we will invest in this project or project is financially viable.