6. A firm is considering two mutually exclusive alternatives as part of a produc

Question

6. A firm is considering two mutually exclusive alternatives as part of a production improvement program. The salvage value of each alternative is zero. At the end of 10 years, alternative A can be replaced with another A with identical cost and benefits. The interest rate is 6%. Using Present worth analysis, which alternative should be selected? Alternative A: Installed cost- $10,000 Annual benefit-$1,625 Useful life 10 years Alternative B: Installed cost $15,000 Annual benefit $1,530 Useful life 20 years A@PW $1,960 A @ PW S3,920 A @ PW S3,055 B@Pw-s2,549

Explanation / Answer

6.

Correct Answer:

C. A@PW = $3055

Working note:

The period for consideration will be 20 years.

Net present worth of alternative A = 1625*(1-1/1.06^20)/.06 - 10000 - 10000/1.06^10

Net present worth of alternative A = $3054.67 or $3055

Net present worth of alternative B = 1530*(1-1/1.06^20)/.06 - 15000

Net present worth of alternative B = $2548.98 or $2549

On the basis of net present worth, Alternative A gives better value, so alternative A should be selected.

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