Question

Please use excel and demonstrate the formulae used.

A regional architecture/contractor firm purchased an HVAC unit for $25,000 that was expected to last 15 years. It has a salvage value of $0 in 10 more years. The annual operating cost of this unit started at $2,000 in the first year and has increased steadily at $250 per year ever since; last year the cost was $3,000. Its book value is now $13,000. They are building a new wing at their regional headquarters to accommodate a much larger computer design emphasis requiring larger, faster computers, architectural printers, e-storage for a construction repository of previous designs, and an increased human heat load. They can buy an additional unit to air-condition the new wing for $18,000. It will have a service life of 15 years, a net salvage of $0 at that time, and a $3,000 market value after 10 years. It will have annual operating costs of $1,800 in the first year, increasing at $100 per year. As an alternative, they can buy a new unit to heat and cool the entire building for $35,000. It will last for 15 years and have a net salvage of $0 at that time; however, it will have a market value of $8,500 after 10 years. It will have first-year operating costs of $3,700/year, increasing at $200 per year. The present unit can be sold now for $7,000. MARR is 11%percent, and the planning horizon is 10 years.

a) Clearly show the cash flow profile for each alternative using a cash flow approach (insider's viewpoint approach).
b) Using a PW analysis and a cash flow approach (insider's viewpoint approach), decide which one is the more favorable alternative.
c) Clearly show the cash flow profile for each alternative using an opportunity cost approach (outsider's viewpoint approach).
d) UsingaPWanalysisandanopportunitycostapproach(outsider'sviewpointapproach), decide which one is the more favorable alternative.

Answer 1

Cash flow for each alternative

Alternative 1	Purchase of New AC and continue with old unit
Alternative 2	Purchase of new unit
Year	1	2	3	4	5	6	7	8	9	10
Alternative 1
outflow
New AC purchase cost	18,000.00	-	-	-	-	-	-	-	-	-
operating cost of AC	3,000.00	3,100.00	3,200.00	3,300.00	3,400.00	3,500.00	3,600.00	3,700.00	3,800.00	3,900.00
operating cost of HVAC	3,250.00	3,500.00	3,750.00	4,000.00	4,250.00	4,500.00	4,750.00	5,000.00	5,250.00	5,500.00
	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	9,400.00
Inflow
Market value of AC										3,000.00
Net outflow	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	6,400.00
Alternative 2
outflow
purchase of new unit	35,000.00
operating cost	3,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	5,700.00
	38,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	5,700.00
Inflow
Scrap realization	7,000.00
Market value of new unit										8,500.00
Net outflow	31,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	-2,800.00

Deciding on favorable alternative

Year	1	2	3	4	5	6	7	8	9	10	Total
cash flow approach
net outflow
Alternative 1	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	6,400.00	93,250.00
Alternative 2	31,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	-2,800.00	67,500.00
Alternative 2 is better as there is less outflow
Preesent value approach
PVIF at 11%	0.9009	0.8116	0.7312	0.6587	0.5935	0.5346	0.4817	0.4339	0.3909	0.3522
Alternative 1
Net outflow	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	6,400.00
Present value of outflow	21,846.83	5,356.56	5,081.84	4,808.51	4,540.28	4,276.80	4,022.20	3,774.93	3,537.65	2,254.08	59,499.66
Alternative 2
Net outflow	31,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	-2,800.00
Present value of outflow	28,738.71	3,327.56	3,144.16	2,964.15	2,789.45	2,619.54	2,456.67	2,299.67	2,149.95	-986.16	49,503.70
Alternative 2 is better as there is less outflow

cash flow profile using opportunity cost

Year	1	2	3	4	5	6	7	8	9	10	Total
cash flow approach
net outflow
Alternative 1	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	6,400.00	93,250.00
Alternative 2	31,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	-2,800.00	67,500.00
Excess outflow if alternative 1 is choosen	-7,650.00	2,500.00	2,650.00	2,800.00	2,950.00	3,100.00	3,250.00	3,400.00	3,550.00	9,200.00	25,750.00

opportunity cost approach using present value method

Year	1	2	3	4	5	6	7	8	9	10	Total
cash flow approach
net outflow
Alternative 1	24,250.00	6,600.00	6,950.00	7,300.00	7,650.00	8,000.00	8,350.00	8,700.00	9,050.00	6,400.00
Alternative 2	31,900.00	4,100.00	4,300.00	4,500.00	4,700.00	4,900.00	5,100.00	5,300.00	5,500.00	-2,800.00
Excess outflow if alternative 1 is choosen	-7,650.00	2,500.00	2,650.00	2,800.00	2,950.00	3,100.00	3,250.00	3,400.00	3,550.00	9,200.00
PVIF at 11%	0.9009	0.8116	0.7312	0.6587	0.5935	0.5346	0.4817	0.4339	0.3909	0.3522
present value of excess outflow	-6,891.89	2,029.00	1,937.68	1,844.36	1,750.83	1,657.26	1,565.53	1,475.26	1,387.70	3,240.24	9,995.96