Question

Two alternatives to incorporate improved techniques to manufacture computer drivers to play HD DVD optical disc formats have been developed and costed. Compare the alternatives below using capitalized cost and interest rate of 8% per year compounded quarterly. Select the CC of best alternative Alternative x Alternative Y First Cost, $ -240000 -168000 Net income, Sper 5000 9000 quarter Upgrade cost, every 10 - 13000 years Salvage value, $ 30000 5 Life, years 00

Answer 1

Alternative X:

First Cost = -240000

Net income per quarter = 5000 for perpetuity.

PV of net income = 5000/(i/4) = 5000 / (0.08/4) = 5000/0.02 = 250000

Upgrade cost Every 10 years or every 40 quarters = -13000

PV of Upgrade cost = -13000/(1+8/400)^40 -13000/(1+8/400)^80 + ... to infinity

PV of Upgrade cost = (-13000 / 1.02^40) * 1 / (1 - 1/1.02^40) = -13000 / 1.02^40 * (1/0.547) = -10763.39

Total PV = -240000 + 250000 - 10763.39 = -763.39

So capitalized cost of alternative X = -763.39

Alternative Y:

Since this project has a limited life, so the project will be repeated once every 5 years. The income and annual costs if any will be for perpetuity

So once every 5 years, the machine will be sold off and a new one will be bought.

First Cost = -168000

Net Income per Quarter = 9000

PV of net income = 9000 / .02 = 450,000

Replacement Cost = -168000+30000 = -138000

PV of Replacement cost = -138000/(1+8/400)^20 - 138000/(1+8/400)^40 - ... to infinity

PV of replacement cost = -138000 / 1.02^20 * 1/ (1-1/1.02^20) = -138000 / 1.02^20 * 1/0.327 = -283981.35

Total PV = -168,000 + 450,000 - 283,981.35 = -1981.35

So capitalized cost of Alternate Y = -1981.35

Since the capitalised cost of Alternate X is less than the capitalized cost of Alternate Y, So alternate X should be selected.

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