two alternative courses two alternative courses two alternative courses two alte
ID: 2565425 • Letter: T
Question
two alternative courses two alternative courses two alternative courses two alternative courses two alternative courses two alternative courses 5-52 Telefono Mexico is expanding its facilities to servea new manufacturing plant. The new plant wil require 2000 telephone lines this year, and another 2000 lines after expansion in 10 years. The plant will be in operation for 30 years. The telephone company is evaluating two options to serve the demand. Option1 Provide one cable now with capacity to serve 4000 lines. The cable cost will be 200,000, and annual maintenance costs will be 15,000. Option 2 Provide a cable with capacity to serve 2000 lines now and a second cable to serve the other 2000 lines in 10 years. The cost of each cable will be 150,000 and each cable will have an annual main tenance of 10,000 The telephone cables will last at least 30 years, and the cost of removing the cables is offset by their salvage value. (a) Which alternative should be selected based on a 10% interest rate? (b) Will your answer to (a) change if the demand for additional lines occurs in 5 years instead of 10 years?Explanation / Answer
1) Alternative can be selected on the basis of NPV.
Option 1:
NPV = -200000*4000 – 15000*4000/1.1^1 – 15000*4000/1.1^2 – 15000*4000/1.1^3 ------- – 15000*4000/1.1^30
= -1365614868
Option 2:
NPV = -150000*2000 – 10000*2000/1.1^1 – 10000*2000/1.1^2 ------- 10000*2000/1.1^10 – 150000*2000/1.1^10 - 10000*4000/1.1^11 – 10000*4000/1.1^12 ------- 10000*4000/1.1^30
= -677559089.2
Since NPV of Alternative 2 is higher, it should be chosen.
2. In this case, since the cable will be required after 5 years, which alterative 2 can’t produce, hence alternative 1 should be chosen.
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