Question

 The Templeton Manufacturing and Distribution Company of​ Tacoma, Washington, is contemplating the purchase of a new conveyor belt system for one of its regional distribution facilities. Both alternatives will accomplish the same task but the Eclipse Model is substantially more expensive than the Sabre Model and will not have to be replaced for 10​ years, whereas the cheaper model will need to be replaced in just 5 years. The costs of purchasing the two systems and the costs of operating them annually over their expected lives is provided​ below:

Year     Eclipse                        Sabre

0          $(1,350,000)                $(750,000)

1          $(26,000)                    $(51,000)

2          $(29,000)                    $(51,000)

3          $(29,000)                    $(57,000)

4          $(29,000)                    $(57,000)

5          $(43,000)                    $(78,000)

6          $(43,000)        

7          $(43,000)        

8          $(43,000)        

9          $(43,000)        

10        $(43,000)        

a. Templeton typically evaluates investments in plant improvements using a required rate of return of 11% What are the NPVs for the two​ systems?

b.  Calculate the equivalent annual costs for the two systems.

c.  Based on your analysis of the two systems using both their NPV and​ EAC, which system do you recommend the company​ pick? ​ Why?

Answer 1

Part-a: NPVs for the two​ systems:

NPV of Eclipse system:

	{1}		{2}	{3} = {1}*{2}
Year	Cash Flows	DF Working	Discounting Factor @ 11%	Present Value
0	(1,350,000.00)	1	1	(1,350,000.00)
1	(26,000.00)	1/1.11^1	0.900900901	(23,423.42)
2	(29,000.00)	1/1.11^2	0.811622433	(23,537.05)
3	(29,000.00)	1/1.11^3	0.731191381	(21,204.55)
4	(29,000.00)	1/1.11^4	0.658730974	(19,103.20)
5	(43,000.00)	1/1.11^5	0.593451328	(25,518.41)
6	(43,000.00)	1/1.11^6	0.534640836	(22,989.56)
7	(43,000.00)	1/1.11^7	0.481658411	(20,711.31)
8	(43,000.00)	1/1.11^8	0.433926496	(18,658.84)
9	(43,000.00)	1/1.11^9	0.390924771	(16,809.77)
10	(43,000.00)	1/1.11^10	0.352184479	(15,143.93)
			NPV:	(1,557,100.03)

.

NPV of Sabre system:

	{1}		{2}	{3} = {1}*{2}
Year	Cash Flows	DF Working	Discounting Factor @ 11%	Present Value
0	(750,000.00)	1	1	(750,000.00)
1	(51,000.00)	1/1.11^1	0.900900901	(45,945.95)
2	(51,000.00)	1/1.11^2	0.811622433	(41,392.74)
3	(57,000.00)	1/1.11^3	0.731191381	(41,677.91)
4	(57,000.00)	1/1.11^4	0.658730974	(37,547.67)
5	(78,000.00)	1/1.11^5	0.593451328	(46,289.20)
			NPV:	(962,853.47)

.

.

Part-b:Equivalent annual costs for the two systems:

Equivalent annual cost for Eclipse system = Net Present Value of Eclipse system/PVIFA(11%,10)

= -1557100.03/5.8892

= -$264,399.25

.

Therefore, Equivalent annual cost for Eclipse system is $264,399.25

.

.

Equivalent annual cost for Sabre system = Net Present Value of Sabre system/PVIFA(11%,5)

= -962853.47/3.6959

= -$260,519.35

.

Therefore, Equivalent annual cost for Sabre system is $260,519.35

.

.

Part-c: Recommendation:

Based on the analysis of the two systems using both their NPV and​ EAC, company should pick Sabre system since it has lower Annual Equivalent Cost as compared to Eclipse system ($260,519.35 < $264,399.25).

Moreover , it has lower negative NPV as compared to negative NPV of Eclipse system.

.

So , company should pick Sabre System.