Two methods can be used for producing solar panels for electric power generation

Question

Two methods can be used for producing solar panels for electric power generation. Method 1 will have an initial cost of $550,000, an annual operating cost of $160,000 per year, and $125,000 salvage value after its three-year life. Method 2 will cost $830,000 with an annual operating cost of $120,000. and a $240,000 salvage value after its five-year life. The company has asked you to determine which method is better, but it Wants the analysis done over a three-year planning period. The salvage value of Method 2 will be 35% higher after three years than it is after five years. If the company's minimum attractive rate of return is 10% per year, which method should the company select?

Explanation / Answer

We will apply the present worth analysis method

PV = Cost / (1+i)^n where n = number of years and i = rate of return

Method 1

NPC (Net Present Cost) = PV of initial investment + Total PV of operating cost - PV of salvage value = 550000/(1.1)^0 + 160000/1.1^1 + 160000/1.1^2 + 160000/1.1^3 - 125000/1.1^3 = $853981.97

Method 2

Salvage value in three years = 1.35 * salvage value in 5 years = 240000*1.35 = $324000

NPC (Net Present Cost) = PV of initial investment + Total PV of operating cost - PV of salvage value = 830000/(1.1)^0 + 120000/1.1^1 + 120000/1.1^2 + 120000/1.1^3 - 324000/1.1^3 = $884996.24

As the NPC of Method 1 is lower so it should be selected.

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