Question

Your company manufactures scientific calculators. There are two options, A and B, that may increase plant capacity. The parameters associated with each option have been estimated. (20 points)

Option	A	B
Initial Cost, $	-45000	-58000
Maintenance Cost, $/year	-8000	-4000
Salvage value, $	4000	6000
Useful Life, years	6	6

a. Evaluate each option and answer which one should be selected based on a net present value comparison at an interest rate of 12% per year? (10 points) b. Your company has a standard practice of evaluating all options over a 3-year period. If a study period of 3 years is used and the salvage values are not expected to change, which option should be selected? (10 points)

Answer 1

a) NPV of option A = -45,000 -8,000(P/A, 12%, 6) + 4,000(P/F, 12%,6)

= -45,000 - 8,000(4.111) + 4,000(0.5066)

= -45,000 - 32,888 + 2,026.4

= -$75,861.6

NPV of option B = -58,000 -4,000(P/A, 12%, 6) + 6,000(P/F, 12%,6)

= -58,000 - 4,000(4.111) + 6,000(0.5066)

= -58,000 - 16,444 + 3,039.6

= -$71,404.4

Option B should be selected.

b) NPV of option A = -45,000 -8,000(P/A, 12%, 3) + 4,000(P/F, 12%,3)

= -45,000 - 8,000(2.402) + 4,000(0.7118)

= -45,000 - 19,216 + 2,847.2

= -$61,368.8

NPV of option B = -58,000 -4,000(P/A, 12%, 3) + 6,000(P/F, 12%,3)

= -58,000 - 4,000(2.402) + 6,000(0.7118)

= -58,000 - 9,608 + 4,270.8

= -$63,337.2

Option A should be selected.