Consider the following cash flows for two types of models: Salvage values repres

Question

Consider the following cash flows for two types of models: Salvage values represent the new proceeds (after tax) from the disposal of assets if they are sold at the end of the year listed. Notice that both models have different service lives. However, Model A will be available in the future with the same cash flows. Model B is available now only. If you select Model B now, you will have to replace it with Model A at the end of year 3. The firm^?s MARR is 6% compounded annually Which model should be selected, assuming that your firm will need one of the two models for an indefinite period?

Explanation / Answer

Option: Use only Model A for 5 years and more: Cash flow Total PV factor Present Value Year Model A Solvage Cashflow at 6% 0 -8000 -8000 1.000000 -8000.00 1 4000 4000 0.943396 3773.58 2 5000 5000 0.889996 4449.98 3 6000 6000 0.839619 5037.72 4 7000 7000 0.792094 5544.66 5 8000 1000 9000 0.747258 6725.32 Total 22000 23000 17531.26 Option: Use Model B for 3 years and replace By model A at the end of 3rd year Cash flow Total PV factor Present Value Year Model A Solvage Cashflow at 6% 0 -15000 -15000 1.000000 -15000 1 8000 8000 0.943396 7547.17 2 8000 8000 0.889996 7119.972 3 0 1000 1000 0.839619 839.6193 4 4000 4000 0.792094 3168.375 5 5000 3000 8000 0.747258 5978.065 Total 10000 14000 9653.201 in year 3 Model B has inflows of 8000, and Model A has Outflows of 8000. So net cashflow is zero. Model A must be selected as its NPV is greater than the Model B.

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