Question

A new alloy can be produced by Process A, which costs $200,000 to implement. The operating cost will be $10,000 per quarter with a salvage value of $25,000 after its 2 year life. Process B will have a first cost of $250,000, an operating cost of $15,000 per quarter, and a $40,000 salvage value after its 4 year life. The interest rate is 8% per year compounded quarterly. What is the present value difference between A and B?

Answer 1

Answer:

Difference between A and B =$42398.5

Process B is better as its PW value is smaller than Process A.

Explanation:

In order to use present worth, both Alternatives must have same time period. Since Process B has 4 years means 16 quarters so we make process A to have 16 quarters two with 2% interest rate per quarter.

Note:

We are going to use Compound Interest tables to simplify our work. Formulas can also be used.

For Process A:

Present value of process A=$-200,000-200,000(P/F,2\%,8)-10,000(P/A,2\%,16)+25,000(P/F,2\%,8)+25,000(P/F,2\%,16)$

Present value of process A=$-200,000-200,000(0.8535)-10,000(13.578)+25,000(0.8535)+25,000(0.7284)$

Present value of process A=-$466,932.5

For Process B:

Present value of process B=$-250,000-15,000(P/A,2\%,16)+40,000(P/A,2\%,16)$

Present value of process B=$-250,000-15,000(13.578)+40,000(0.7284)$

Present value of process B=-$424,534

Difference between A and B =(-$424,534)-(-$466,932.5)

Difference between A and B =$42398.5

Process B is better as its PW value is smaller than Process A.