An electric switch manufacturing company has to choose one of the three differen

Question

An electric switch manufacturing company has to choose one of the three different assembly methods. Method A will have a first cost of $40,000, an annual operating cost of 9,000 and a service life of 2 years. Method B will cost $80,000 to buy and will have an annual operating cost of $6000 over its 4-year service life. Method C will cost $130,000 initially with an annual operating cost of $4000 over its 8 year life. Methods A and B will have no salvage value, but Method C will have some equipment worth an estimated $12,000, Which method should be elected? Use present worth analysis at an interest rate of %10 per year.

Explanation / Answer

If I remember correctly: you'll need to discount future years annual operating costs to bring them to present value dollars before adding everything together. Present cost = F/(1+r)^0 + F/(1+r)^1 + ... This should be done for the life of the equipment. So total costs for life of equipment: A = 57181 B = 100921 C = 153473 - 12000 (salvage) Costs per year on average will be the determining factor however. A = 28590 /year of life of equipment B = 25230 /year C = 17684 /year Thus I would say that method C would be the most cost effective.

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