Question

Two hammer mills are under consideration for installation in a gypsum mill. Machine A has a first cost of $18,000, no salvage value at the end of its 6 year life and annual operating costs of $10,000. Machine B costs $32,000 and has a salvage value of $8000 at the end of its 9 year life. Operating costs for Machine B are $8000 per year. Using the common multiple method, compare the two alternatives on the basis of their present worths using a minimum rate of return of 10%. Draw the cash flow diagrams for both alternatives. Ir the hammer mills in Question 1 were only required for 6 years, what salvage value would be required for Machine B to justify its purchase?

Answer 1

Analysis will be for 6 yrs, no common multiple is required

Let Salvage value be S for alternative B

NPW of A = -18000 - 10000 * (P/A, 10%,6)

= -18000 - 10000 * 4.355261

= -61552.61

NPW of B = -32000 - 8000 * (P/A, 10%,6) + S*(P/F, 10%,6)

= -32000 - 8000 * 4.355261 + S * 0.564474

= -66842.08 + S * 0.564474

As per condition given in question

-66842.08 + S * 0.564474 = -61552.61

S * 0.564474 = -61552.61 + 66842.08 = 5289.47

S = 5289.47 /  0.564474

S = 9370.62