1. A firm is considering 2 options: A B First cost 10.7K 5.5K Annual benefits 2.

Question

1. A firm is considering 2 options:

                                          A                      B

First cost                             10.7K            5.5K

Annual benefits                    2.1K             1.8K

Salvage                                      0                  0

Useful life (yrs)                         8                   4

At what interest rate (integer) is option A = option B?

2. Three projects are being considered:

                                           A                              B                  C

First cost                          1,000                     2,000          3,000

Annual benefits                  150                        150                   0

Salvage                            1,000                      2,700           5,600

Life in years                            5                           6                   7

When each life is reached, the machines will be salvaged, with no replacement.

At 8%, which project should be chosen?

Explanation / Answer

1
Let the rate be 'i'.
We need both the NPV to be same.
-10700 + 2100*PVA(i%,8) = -5500 + 1800*PVA(i%,4)
2100*PVA(i%,8) - 1800*PVA(i%,4) = -5500 + 10700
2100*PVA(i%,8) - 1800*PVA(i%,4) = 5200
On solving we get i=11%

Thus, at 11%, bith the projects are same.

2
NPV(A) = -1000 + 150*PVA(8%,5) + 1000*PV(8%,5)
= 279.53

NPV(B) = -2000 + 150*PVA(8%,6) + 2700*PV(8%,6)
= 394.91

NPV(C) = -3000 + 0*PVA(8%,7) + 1000*PV(8%,7)
= 267.55

Thus, we should select Project B

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.