Question

It is estimated that the annual sales of an energy saving device will be 20,000 the first year and increase by 10,000 per year unitl 50,000 units are sold during the fourth year. Proposal A is to purchase manufacturing equipment costing $120,000 with an estimated salvage value of $15,000 at the end of 4 years.Proposal B is to purchase equipment costing $280,000 with an estimated salvage value of $32,000 at the end of 4 years. The variable manufacturing cost per unit under proposal A is estimated to be $8,00, but is estimated to be only $2.60 under proposal B. If the interest rate is 9%, which proposal should be accepted for a 4-year production horizon?

Answer 1

Answer:

Proposal B should be accepted

Explanation:

                                             1              2                3              4

Sales(Units)                     20,000    30,000     40,000     50,000  

Variable Cost (A)            160,000   240,000  320,000   400,000- 15,000  

Variable Cost (B)            52,000     78,000    104,000    130,000 - 32,000  

PV Factor(9%)                   0.917        0.841      0.772        0.708  

PV OF Variable Cost(A)  146,720   201,840   247,040    272,580  

PV of Variable Cost(B)   47,684      65,598    80,288     69,384  

Total PV of Variable Cost of A: $868,180

Total PV of Variable Cost of B: $262,954

Difference in PV of Expenses= $605,226

Difference in PV of Outflow = 280,000 - 120,000 = $160,000

So, Proposal B should be accepted because it has a cost saving of Net $445,226 (605,226 - 160,000).