With a MARR of 15%, an engineer is proposing a project that will cost $55,000 to
ID: 2577960 • Letter: W
Question
With a MARR of 15%, an engineer is proposing a project that will cost $55,000 to put the asset in place. She is confident that the revenue stream will be around $25,000 annually with fixed costs of $8,000. She projects the useful life is 5 years and will get a salvage value of $7000. However the engineer is concerned about this projection, particularly what the market price of the used asset will be. Is she correct and the decision is sensitive to the salvage price?
No
Yes
After making his pitch to management, the engineer is directed to run the analysis on his project without any salvage value but checking for sensitivity of costs as there is sure to be additional variable costs involved. At what percentage increase of the costs is the project no longer viable?
> 20%
> 5%
> 10%
> 15%
> 25%
Explanation / Answer
1) Net annual cash inflows = $25000-$8000 = $ 17,000 PV of the net cash inflows = 17000*PVIFA(15,5) = 17000*3.35216 = $ 56,987 As the PV of the net cash inflows is more than the project cost of $55,000, the Engineer need not worry about the salvage value. Even with '0' salvage value the project would have a positive NPV, which would make it acceptable. Is she correct and the decision is sensitive to the salvage price? NO, the decision is not sensitive to salvage price. 2) With no salvage value the project is viable till the NPV is 0. For NPV to be 0, the PV of net cash inflows should be only $55000. For a PV of $55000, the annual net cash inflows would be 55000/3.35216 = 16407 Relevant expenses would be 25000-16407 = 8593 Increase in expenses = 8593/8000-1 = 7.41% Hence, the project is not viable where the % increase in cost is > 5%.
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