Suppose that X Company wants to install a new inspection system. There are two o

Question

Suppose that X Company wants to install a new inspection system. There are two options given by two different companies: Option 1: Purchasing Cost-$20,000, Operating Cost $6,000, Salvage Value-$4,000, Lifetime 3 years Option 2: Purchasing Cost $32,000, Operating Cost-$5,000, Salvage Value-$5,000, Lifetime!5 years Given that the chosen inspection system will be used indefinitely (i.e. required service period is infinity), and assuming that price, costs will not change, which model should be chosen at MARR-12% using present worth analysis?

Explanation / Answer

For perpetuity, we will not consider the terminal cash flow (i.e. the salvage value) and the life (because the assumption is that the life is infinite).

For Option 1 = PV of operating expense = $6000 / 0.12 = $50000 (perpetuiry)
Initial investment = $20000
Total PV = $20000 + $50000 = $70000

For Option 2 = PV of operating expense = $5000 / 0.12 = $41666.67 (perpetuity)
Initial investment = $32000
Total PV = $32000 + $41666.67 = $73666.67

So, option 1 is less costly and should be chosen

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