Question

Two methods can be used to produce solar panels for electric power generation. Method 1 will have an initial cost of $560,000, an AOC of $170,000 per year, and $115,000 salvage value after its 3-year life. Method 2 will cost $870,000 with an AOC of $115,000 and a $170,000 salvage value after its 5-year life. Assume your boss asked you to determine which method is better, but she wants the analysis done over a three-year planning period. You estimate the salvage value of Method 2 will be 28% higher after three years than it is after five years. If the MARR is 11% per year, which method should the company select?

The company should select method 1 or method 2 ?

Answer 1

Year	Method 1	Method 2	PV Factor Calculation	PV Factor @ 11 % (F)	Method 1	Method 2
	Cash Flow C1	Cash Flow C2			PV = C1 x F	PV = C2 x F
0	$560,000	$870,000	1/(1+11%)^0	1	$560,000	$870,000
1	$170,000	$115,000	1/(1+11%)^1	0.900900901	$153,153	$103,604
2	$170,000	$115,000	1/(1+11%)^2	0.811622433	$137,976	$93,337
3	$55,000	($102,600)	1/(1+11%)^3	0.731191381	$40,216	($75,020)
				NPC	$891,344	$991,920

Cash flow or cost for year 3 for Method 1 = Annual operating cost – salvage value

                                                                          = $ 170,000 - $ 115,000 = $ 55,000

Cash flow or cost for year 3 for Method 2 = Annual operating cost – salvage value

                                                                          = $ 115,000 – [$ 170,000 x (1.28)]

                                                                          = $ 115,000 - $ 217,600 = - $ 102,600

As the present value of cost for Method 1 is less than Method 2 for a range of three year periods, Method 1 should be selected.