Question

3. A manufacturing company is planning to install an air-conditioning system at its main office. The company receives two offers, System A and System B. Both systems are suitable for use by the company. The costs of both systems are tabulated in TABLE Q3. Assume both systems will provide comparable comfort service and will be used for 10 years. Interest rate is 10%. The air-conditioning will only be operated from year 2 onwards. TABLE Q3 No System A (RM) 55,000 System B (RM) 60,000 Main Equipment (to buy at year 0) 12,000 10,000 15,000 12,000 Installation (will be done at year 1) Annual cost of electricity The electricity will be used beginning from year 2. Annual maintenance expense. Maintenance will start from year 3 Overhaul cost during at the end of year 5 10,000 8,000 20,000 15,000 Market value at the end of year 10 5,000 10,000 a. Draw cash flow for system A and system B. [6 marks] b. Evaluate the present worth of System A and System B. (12 marks] C. Recommend the system the company should select. Justify. [2 marks] d. If the cost of annual maintenance increase by RM1,000 every year from year 3 to year 10 for both System A and System B, other costs remain the same as per TABLE Q3, evaluate the present worth of System A and System B. [10 marks]

Answer 1

a. & b. Cash flows for System A and System B and Evaluation of present worth of System A and System B:

		Cashflows	Discounting Factor @ 10%	Present Value of Cashflows
Year	Particulars	System A (RM)	System B (RM)	System A (RM)	System B (RM)
(A)	(B)	(C )	(D)	(E )	(F) = (C ) x (E )	(G) = (D ) x (E )
Now	Main Equipment	(55,000)	(60,000)	1	(55,000)	(60,000)
Year 1	Installation cost	(12,000)	(10,000)	0.9091	(10,909)	(9,091)
Year 2 to 10	Annual cost of electricity from Year 2 to Year 10	(15,000)	(12,000)	5.2355	(78,533)	(62,826)
Year 3 to 10	Annual maintenance cost from Year 3 to Year 10	(10,000)	(8,000)	4.409	(44,090)	(35,272)
Year 5	Overhaul cost at the end of Year 5	(20,000)	(15,000)	0.6209	(12,418)	(9,314)
Year 10	Market value at the end of Year 10	5,000	10,000	0.3855	1,928	3,855
	Present Value of the Systems (RM)				(199,022)	(172,648)

Evaluation: From the above, the present worth of System A is (RM199,022) and present worth of System B is (RM72,648).

c. Recommendation : Since the cost incurred for System B is lower than the in terms of present value when compared with the System A, hence System B is should be purchased by the Company.

d. Calculation of present worth of System A and System B, if the maintenance cost is increased by RM1,000 every year from year 3 to year 10:

Total annual maintenance cost for System A = 10,000 + 1,000 = RM11,000

Total annual maintenance cost for System B = 8,000 + 1,000 = RM9,000

		Cashflows	Discounting Factor @ 10%	Present Value of Cashflows
Year	Particulars	System A (RM)	System B (RM)	System A (RM)	System B (RM)
(A)	(B)	(C )	(D)	(E )	(F) = (C ) x (E )	(G) = (D ) x (E )
Now	Main Equipment	(55,000)	(60,000)	1	(55,000)	(60,000)
Year 1	Installation cost	(12,000)	(10,000)	0.9091	(10,909)	(9,091)
Year 2 to 10	Annual cost of electricity from Year 2 to Year 10	(15,000)	(12,000)	5.2355	(78,533)	(62,826)
Year 3 to 10	Annual maintenance cost from Year 3 to Year 10	(11,000)	(9,000)	4.409	(48,499)	(39,681)
Year 5	Overhaul cost at the end of Year 5	(20,000)	(15,000)	0.6209	(12,418)	(9,314)
Year 10	Market value at the end of Year 10	5,000	10,000	0.3855	1,928	3,855
	Present Value of the Systems (RM)				(203,431)	(177,057)

Present worth of System A is (RM203,431) and Present worth of System A is (RM177,057).

NOTE: It is assumed that all the cashflows are occured at the end of the Year.