Question

Your company is considering one of two product lines. Using present worth analysis, which option should be selected. Assume a 6% interest rate. Both products cost $1 in material, labor and supplies are sold for $2 per unit. Option 1: A special piece of equipment is purchased for $3000 to produce the product. There is no additional maintenance or tooling required. The first year 1000 units are produced. The second year 800, the third year 600, the fourth thru tenth year 400. Option 2: A special piece of equipment is purchased for $2000 to produce the product. There is no additional maintenance or tooling required. 500 units are produced each year. Draw the cash flow diagram for each option and do a Present Worth Analysis. Which option maximizes the present worth?

Answer 1

Year	Option 1 CashFlows	PVIF @6%	PV of cashflows @6%	Option 2 CashFlows	PVIF @6%	PV of cashflows @6%
0	-3000	1.0000	-3000	-2000	1.0000	-2000
1	1000	0.9434	943	500	0.9434	472
2	800	0.8900	712	500	0.8900	445
3	600	0.8396	504	500	0.8396	420
4	400	0.7921	317	500	0.7921	396
5	400	0.7473	299	500	0.7473	374
6	400	0.7050	282	500	0.7050	352
7	400	0.6651	266	500	0.6651	333
8	400	0.6274	251	500	0.6274	314
9	400	0.5919	237	500	0.5919	296
10	400	0.5584	223	500	0.5584	279
	NPV		1034			1680
	Since NPV of option 2 is higher it maximizes the present worth