Question

One of two methods must be used to produce expansion anchors. Method A costs $80,000 initially and will have a $15,000 salvage value after 3 years. The operating cost with this method will be $30,000 per year. Method B will have a first cost of $120,000, an operating cost of $8,000 per year, and a $40,000 salvage value after its 3-year life. At an interest rate of 8% per year, the present worth of Method B is closest to:

Answer 1

Answer:

At an interest rate of 8% per year, the present worth of Method B is closest to:

=  $108,856.

Explanation:

a) Data and Calculations:

                                      Method A     Method B

Initial investment            $80,000     $120,000

Salvage value                    15,000        40,000

Period of investment       3 years        3 years

Annual operating costs $30,000       $8,000

Interest rate per year           8%               8%

Present value annuity factor = 2.577

Discounted present value factor = 0.794

Present worth:

                                                            Method B    Method A

Initial investment cost ($120,000 * 1) $120,000     $80,000

Operating costs = ($8,000 * 2.577) =     20,616         77,310

Salvage value = $40,000 * 0.794 =       (31,760)        (11,910)

Present worth =                                  $108,856    $145,400

b) Using the present worth analysis technique, Method B should be used to produce the expansion anchors, as it costs less than Method A.  The present worth analysis method is an equivalence method of discounting a project's cash flows to a single present value.  With this analysis, it becomes easier to determine the project that should be accepted or rejected based on their economic realities.