The following cost data for a maker of oilrigs is available. Using annual cash f
ID: 1091679 • Letter: T
Question
The following cost data for a maker of oilrigs is available. Using annual cash flow analysis at a MARR of 15%; choose the better of the two alternatives.
Data
Alt. 1
Alt. 2
Initial Cost
$100,000
$200,000
Operating Costs /year
$50,000
$85,000
Annual Benefits
$100,000
$175,000
Salvage Value
$10,000
$20,000
Useful Life
5 Years
6 Years
Alt. 1, EUAW = $21,653
Alt. 2, EUAW = $36,233
Alt. 2, EUAW = $39,444
Alt. 1, EUAW = $23,405
Data
Alt. 1
Alt. 2
Initial Cost
$100,000
$200,000
Operating Costs /year
$50,000
$85,000
Annual Benefits
$100,000
$175,000
Salvage Value
$10,000
$20,000
Useful Life
5 Years
6 Years
Explanation / Answer
First find Annual Net Present Value of both alternatives.
Both alternatives have same format, initial cost + annual cash flow (benefit - cost) + salvage value (at last year of project). Salvage value of Alt. 1 at year 5, salvage value for Alt. 2 at year 6.
NPV Alt. 1 = -100,000 + (100,000 - 50,000) * [(1+0.15)^5-1] / [0.15 (1+0.15)^5] + 10,000 / (1+0.15)^5
NPV Alt. 1 = -100,000 + 167,607.75 + 4,971.77
NPV Alt. 1 = $72,579.52
NPV Alt. 2 = -200,000 + (175,000 - 85,000) * [(1+0.15)^6-1] / [0.15 (1+0.15)^6] + 20,000 / (1+0.15)^6
NPV Alt. 2 = -200,000 + 340,603.44 + 8,646.55
NPV Alt. 2 = $149,249.99
Now NPV is calculates, using those NPV's as PV, find the yearly annuity for Annual cash flow of each alternate.
PV = A [(1+r)^n-1] / [r (1+r)^n]
Alt. 1: 72,579.52 = EUAW [(1+0.15)^5-1] / [0.15 (1+0.15)^5]
EUAW Alt. 1 = 21,651.60
Alt. 2: 149,249.99 = EUAW [(1+0.15)^6-1] / [0.15 (1+0.15)^6]
EUAW Alt. 2 = 39,437.36
Alternate 2 is better, and closest answer choice is C
C. Alt. 2, EUAW = $39,444.............(answer)
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