Question

Using information from Question 6, determine the better option at interest rate 15% using Present Worth Analysis. Please solve using Excel if possible.

Question 6: A company is considering purchasing the following 4 different pieces of equipment of the same useful life of 5 years. The company can obtain a 15% annual return on its investment in other projects and is willing to invest money on one of the four pieces, as long as it can obtain 15% annual return on each increment of money invested. Which one, if any, of the alternatives should be selected? Use rate of return analysis.

	A	B	C	D
Initial investment Annual savings Annual cost	$10,000 $4,000 $2,000	$18,000 $6,000 $3,000	$25,000 $7,500 $3,000	$30,000 $9,000 $4,000

Answer 1

The present worth analysis discounts the cash flow using specified interest rate. The option with the highest present worth is selected in this method.
PW = Cash Flow / (1+Interest Rate)^Duration

Option A
PW of initial investment
-10000 / (1.15 ^ 0) = -10000

PW of annual benefits
=PV(15%,5,-4000)
= 13408.62

PW of annual cost
=PV(15%,5,2000)
= -6704.31

NPW = (-10000 + 13408.62 - 6704.31)
NPW = -3295.69

We can carry similar calculations for other options.
The results are tabulated below

	Option A	Option B	Option C	Option D
Initial Cost	-10000	-18000	-25000	-30000
Annual Benefits	4000	6000	7500	9000
Annual Cost	-2000	-3000	-3000	-4000
Life in Years	5	5	5	5
	PW @ 15%	PW @ 15%	PW @ 15%	PW @ 15%
Initial Cost	-10000	-18000	-25000	-30000
Annual Benefits	13408.62	20112.93	25141.16	30169.40
Annual Cost	-6704.31	-10056.47	-10056.47	-13408.62
NPW	-3295.69	-7943.53	-9915.30	-13239.22

Option A has a higher NPW so it shoul be selected.