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Two mutually exclusive alternatives are being considered for pollution control e

ID: 2729658 • Letter: T

Question

Two mutually exclusive alternatives are being considered for pollution control equipment. The economic data is given below:

                                                            A                                 B

Initial cost                               $20,000                       $38,000

Annual expenses                     $5,500                         $5,000

Useful life                               5 years                         9 years

Salvage value at the end         $1,000                         $3,000

Of useful life

The study period is 9 years. If alternative A is selected, a portable system would be leased for the last 4 years at a cost of $10,000 per year including all expenses. If the MARR is 15% per year, which alternative should be selected?

Explanation / Answer

For Alternative A,

Present value of annuity factor PVAF(r,n) = {1-(1+r)-n}/r

PVAF (15%,5) = (1-1.15-5)/0.15 = 3.3522

PVAF(15%,4) = (1-1.15-4)/0.15 = 2.8550

Present value of annual expenses = $5,500 * 3.3522 = $18,437.10

Present value of lease expenses at the end of Year 5 = $10,000*2.8550 = $28,550

Present value of lease expenses as on today = $28,550/1.155 = $14,194.40

Present value of salvage value = $1,000/1.155 = $497.18

Total present worth = Initial cost + Preent value of annual expenses + present value of lease expenses – Present value of salvage value

Total present worth = $20,000 + $18,437.10 + $14,194.40 - $497.18 = $52,134.32

For Alternative B,

Present value of annuity factor PVAF(r,n) = {1-(1+r)-n}/r

PVAF (15%,9) = (1-1.15-9)/0.15 = 4.7716

Present value of annual expenses = $5,000 * 4.7716 = $23,858

Present value of salvage value = $3,000/1.159 = $852.78

Total present worth = Initial cost + Present value of annual expenses – Present value of salvage value

Total present worth = $38,000 + $23,858, - $852.78 = $61,005.32

Hence Alternative A should be selected

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