8-19 Andrews Manufacturing offers three models for one of its products to its cu
ID: 2782652 • Letter: 8
Question
8-19 Andrews Manufacturing offers three models for one of its products to its customers. You have been asked to analyze the choices from the customer's pers tive. Which model should a customer choose if each model has a life of 12 years? Doing nothing is an alternative. pec- Alternative Deluxe Regular Economy $220,000 $125,000 $75,000 79,000 43,000 28,000 Maintenance and 38,000 13,000 8,000 First cost Annual benefit operating costs Salvage value 16,000 6,900 3,000 (a) Construct a choice table for interest rates from 0% to 100%. (b) MARR = 15%. Using incremental rate of return analysis, which alternative, if any, should the customer choose?Explanation / Answer
(a) To construct a choice table for various interest rates, we first plot the cash flows of the various alternatives over the 12 year life as below:
Year
Deluxe
Regular
Economy
0
(220,000)
(125,000)
(75,000)
1
41,000
30,000
20,000
2
41,000
30,000
20,000
3
41,000
30,000
20,000
4
41,000
30,000
20,000
5
41,000
30,000
20,000
6
41,000
30,000
20,000
7
41,000
30,000
20,000
8
41,000
30,000
20,000
9
41,000
30,000
20,000
10
41,000
30,000
20,000
11
41,000
30,000
20,000
12
57,000
36,900
23,000
Notes:
Using these cashflows, we can build the choice table with Net Present Values (NPV) for various interest rates as shown below:
Net Present Values
Year
Deluxe
Regular
Economy
Interest rates
Deluxe
Regular
Economy
0
(220,000)
(125,000)
(75,000)
0%
288,000
241,900
168,000
1
41,000
30,000
20,000
5%
152,303
144,740
103,936
2
41,000
30,000
20,000
10%
64,459
81,609
62,230
3
41,000
30,000
20,000
15%
5,236
38,908
33,973
4
41,000
30,000
20,000
20%
(36,198)
8,950
14,121
5
41,000
30,000
20,000
25%
(66,170)
(12,772)
(291)
6
41,000
30,000
20,000
30%
(88,513)
(28,996)
(11,066)
7
41,000
30,000
20,000
35%
(105,617)
(41,437)
(19,335)
8
41,000
30,000
20,000
40%
(119,026)
(51,201)
(25,829)
9
41,000
30,000
20,000
45%
(129,758)
(59,025)
(31,035)
10
41,000
30,000
20,000
50%
(138,509)
(65,409)
(35,285)
11
41,000
30,000
20,000
55%
(145,759)
(70,702)
(38,810)
12
57,000
36,900
23,000
60%
(151,853)
(75,153)
(41,774)
65%
(157,039)
(78,943)
(44,299)
70%
(161,502)
(82,205)
(46,472)
75%
(165,380)
(85,040)
(48,362)
80%
(168,780)
(87,526)
(50,019)
85%
(171,785)
(89,724)
(51,483)
90%
(174,458)
(91,679)
(52,786)
95%
(176,851)
(93,429)
(53,953)
100%
(179,006)
(95,006)
(55,004)
The above table shows the NPVs of the alternatives at various interest rates. The choice of the alternative would be that which has the highest NPV at the relevant interest rate.
(b) If MARR is 15%, the alternative to choose would be "Regular" as it has higher positive NPV than Deluxe & Economy alternatives as shown in the above table.
Year
Deluxe
Regular
Economy
0
(220,000)
(125,000)
(75,000)
1
41,000
30,000
20,000
2
41,000
30,000
20,000
3
41,000
30,000
20,000
4
41,000
30,000
20,000
5
41,000
30,000
20,000
6
41,000
30,000
20,000
7
41,000
30,000
20,000
8
41,000
30,000
20,000
9
41,000
30,000
20,000
10
41,000
30,000
20,000
11
41,000
30,000
20,000
12
57,000
36,900
23,000
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