A large profitable corporation is considering two mutually exclusive capital inv

Question

A large profitable corporation is considering two mutually exclusive capital investments:

Alt A.
Initial Cost: 11,000
Uniform Annual Benefit: 3,000
End of depreciable life salvage value: 2,000
Depreciation method: straight-line depreciation
End of useful life salvage value obtained: 2,000
Depreciable life, in years: 3
Useful life, years: 5


Alt B.
Initial Cost: 33,000
Uniform Annual Benefit: 9,000
End of depreciable life salvage value: 3,000
Depreciation method: Sum-of-years'-digits
End of useful life salvage value obtained: 5,000
Depreciable life, in years: 4
Useful life, years: 5

If the firms after-tax minimum attractive rate of return is 12%, and its combined incremental

Explanation / Answer

Alternative A:

Initial Cost = $11,000

Uniform Annual Benefit = $3,000’

Salvage value = $2,000

Useful life = 5 years

NPW = $3,000 (P/A, 12%, 5) + $2,000 (P/F, 12%, 5) - $2,000 (P/F, 12%, 3) - $11,000

NPW = $3,000 (3.6048) + $2,000 (0.5674) - $2,000 (0.7118) - $11,000

NPW = $10,814.40 + $1,134.80 - $1,423.60 - $11,000

NPW = -$474.40

Alternative B:

Initial Cost = $33,000

Uniform Annual Benefit = $9,000

Salvage Value = $5,000

Useful life = 5 years

NPW = $9,000 (P/A, 12%, 5) + $5,000 (P/F, 12%, 5) - $3,000 (P/F, 12%, 4) - $33,000

NPW = $9,000 (3.6048) + $5,000 (0.5674) - $3,000 (0.6355) - $33,000

NPW = $32,443.20 + $2,837 - $1,906.50 - $33,000

NPW = $373.70

Note: Using Net Present worth Method, Alternative B has got highest Net Present Value. Hence, Alternative B would be better for selection.

Select Alternative B

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